Handout 3 (Chapter 7)

Questions and Problems

BASIC
(Q uestions 1–17)
1. Interpreting Bond Yields [ LO1] Is the yield to maturity on a bond the same thing as the
required return? Is YTM the same thing as the coupon rate? Suppose today a 10 percent
coupon bond sells at par. Two years from now, the required return on the same bond is 8
percent. What is the coupon rate on the bond then? The YTM?
2. Interpreting Bond Yields [ LO2] Suppose you buy a 7 percent coupon, 20-year bond today
when it’s first issued. If interest rates suddenly rise to 15 percent, what happens to the value of
your bond? Why?
3. Valuing Bonds [ LO2] Even though most corporate bonds in the United States make coupon
payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose
a German company issues a bond with a par value of € 1,000, 27 years to maturity, and a
coupon rate of 3.6 percent paid annually. If the yield to maturity is 3.2 percent, what is the
current price of the bond in euros?
4. Bond Yields [ LO2] A Japanese company has a bond outstanding that sells for 96.318
percent of its ¥ 100,000 par value. The bond has a coupon rate of 3.4 percent paid annually
and matures in 16 years. What is the yield to maturity of this bond?
5. Coupon Rates [ LO2] Nikita Enterprises has bonds on the market making annual payments,
with eight years to maturity, a par value of $1,000, and selling for $962. At this price, the
bonds yield 5.1 percent. What must the coupon rate be on the bonds?
6. Bond Prices [ LO2] Westco Co. issued 15-year bonds a year ago at a coupon rate of 5.4
percent. The bonds make semiannual payments and have a par value of $1,000. If the YTM on
these bonds is 4.5 percent, what is the current price of the bond in dollars?
7. Bond Yields [ LO2] Ashburn Corp. issued 25-year bonds two years ago at a coupon rate of
5.6 percent. The bonds make semiannual payments. If these bonds currently sell for 97
percent of par value, what is the YTM?
8. Coupon Rates [ LO2] Draiman Corporation has bonds on the market with 14.5 years to
maturity, a YTM of 5.3 percent, a par value of $1,000, and a current price of $987. The bonds
make semiannual payments. What must the coupon rate be on these bonds?
9. Z ero Coupon Bonds [ LO2] You find a zero coupon bond with a par value of $10,000 and 24
years to maturity. If the yield to maturity on this bond is 4.2 percent, what is the dollar price
of the bond? Assume semiannual compounding periods.
10. Valuing Bonds [ LO2] Yan Yan Corp. has a $2,000 par value bond outstanding with a
coupon rate of 4.7 percent paid semiannually and 13 years to maturity. The yield to maturity
of the bond is 5.05 percent. What is the dollar price of the bond?
11. Valuing Bonds [ LO2] Union Local School District has a bond outstanding with Page 240
a coupon rate of 2.9 percent paid semiannually and 16 years to maturity. The yield
to maturity on this bond is 2.7 percent, and the bond has a par value of $5,000. What is the
dollar price of the bond?
12. Calculating Real Rates of Return [ LO4] If Treasury bills are currently paying 4.6 percent
and the inflation rate is 1.9 percent, what is the approximate real rate of interest? The exact
real rate?
13. Inflation and Nominal Returns [ LO4] Suppose the real rate is 1.8 percent and the inflation
rate is 2.7 percent. What rate would you expect to see on a Treasury bill?
14. Nominal and Real Returns [ LO4] An investment offers a total return of 11.7 percent over the
coming year. Janice Yellen thinks the total real return on this investment will be only 9
percent. What does Janice believe the inflation rate will be over the next year?
15. Nominal versus Real Returns [ LO4] Say you own an asset that had a total return last year of
14.1 percent. If the inflation rate last year was 2.83 percent, what was your real return?
16. Using Treasury Quotes [ LO2] Locate the Treasury issue in Figure 7.5 maturing in
February 2029. What is its coupon rate? What is its bid price? What was the previous day’s
asked price? Assume a par value of $10,000.
17. Using Treasury Quotes [ LO2] Locate the Treasury bond in Figure 7.5 maturing in
November 2026. Is this a premium or a discount bond? What is its current yield? What is its
yield to maturity? What is the bid-ask spread in dollars? Assume a par value of $10,000.
INTERMEDIATE
(Q uestions 18–31)
18. Bond Price Movements [ LO2] Bond X is a premium bond making semiannual payments.
The bond pays a coupon rate of 6.8 percent, has a YTM of 6.2 percent, and has 13 years to
maturity. Bond Y is a discount bond making semiannual payments. This bond pays a coupon
rate of 6.2 percent, has a YTM of 6.8 percent, and also has 13 years to maturity. The bonds
have a par value of $1,000. What is the price of each bond today? If interest rates remain
unchanged, what do you expect the price of these bonds to be 1 year from now? In 3 years? In
8 years? In 12 years? In 13 years? What’s going on here? Illustrate your answers by graphing
bond prices versus time to maturity.
19. Interest Rate Risk [ LO2] Both Bond Sam and Bond Dave have 7.1 percent coupons, make
semiannual payments, and are priced at par value. Bond Sam has 3 years to maturity, whereas
Bond Dave has 20 years to maturity. If interest rates suddenly rise by 2 percent, what is the
percentage change in the price of Bond Sam? Of Bond Dave? If rates were to suddenly fall by
2 percent instead, what would the percentage change in the price of Bond Sam be then? Of
Bond Dave? Illustrate your answers by graphing bond prices versus YTM. What does this
problem tell you about the interest rate risk of longer-term bonds?
20. Interest Rate Risk [ LO2] Bond J has a coupon rate of 3 percent. Bond K has a coupon rate
of 9 percent. Both bonds have 18 years to maturity, make semiannual payments, and have a
YTM of 6 percent. If interest rates suddenly rise by 2 percent, what is the percentage price
change of these bonds? What if rates suddenly fall by 2 percent instead? What does this
problem tell you about the interest rate risk of lower-coupon bonds?
Handout 4 (Chapter 8)

Questions and Problems

Basic
(Q uestions 1–13)
1. Stock Values [ LO1] The RLX Co. just paid a dividend of $3.20 per share on its stock. The
dividends are expected to grow at a constant rate of 4 percent per year indefinitely. If investors
require a return of 10.5 percent on the company’s stock, what is the current price? What will
the price be in 3 years? In 15 years?
2. Stock Values [ LO1] The next dividend payment by Im, Inc., will be $1.87 per share. The
dividends are anticipated to maintain a growth rate of 4.3 percent forever. If the stock
currently sells for $37 per share, what is the required return?
3. Stock Values [ LO1] For the company in the previous problem, what is the dividend yield?
What is the expected capital gains yield?
4. Stock Values [ LO1] Five Star Corporation will pay a dividend of $3.04 per share next year.
The company pledges to increase its dividend by 3.75 percent per year indefinitely. If you
require a return of 11 percent on your investment, how much will you pay for the company’s
stock today?
5. Stock Valuation [ LO1] Caccamise Co. is expected to maintain a constant 3.4 percent growth
rate in its dividends indefinitely. If the company has a dividend yield of 5.3 percent, what is the
required return on the company’s stock?
6. Stock Valuation [ LO1] Suppose you know that a company’s stock currently sells for $78 per
share and the required return on the stock is 10.9 percent. You also know that the total return
on the stock is evenly divided between a capital gains yield and a dividend yield. If it’s the
company’s policy to always maintain a constant growth rate in its dividends, what is the
current dividend per share?
7. Stock Valuation [ LO1] Hailey Corp. pays a constant $9.45 dividend on its stock. Page 266
The company will maintain this dividend for the next 13 years and will then cease
paying dividends forever. If the required return on this stock is 10.7 percent, what is the
current share price?
8. Valuing Preferred Stock [ LO1] Fegley, Inc., has an issue of preferred stock outstanding that
pays a $3.80 dividend every year in perpetuity. If this issue currently sells for $93 per share,
what is the required return?
9. Stock Valuation and Required Return [ LO1] Red, Inc., Yellow Corp., and Blue Company
each will pay a dividend of $4.15 next year. The growth rate in dividends for all three
companies is 4 percent. The required return for each company’s stock is 8 percent, 11 percent,
and 14 percent, respectively. What is the stock price for each company? What do you conclude
about the relationship between the required return and the stock price?
10. Voting Rights [ LO3] After successfully completing your corporate finance class, you feel the
next challenge ahead is to serve on the board of directors of Cornwall Enterprises.
Unfortunately, you will be the only person voting for you. If the company has 720,000 shares
outstanding, and the stock currently sells for $48, how much will it cost you to buy a seat if the
company uses straight voting?
11. Voting Rights [ LO3] In the previous problem, assume that the company uses cumulative
voting, and there are four seats in the current election. How much will it cost you to buy a seat
now?
12. Stock Valuation and PE [ LO2] The Dahlia Flower Co. has earnings of $3.64 per share. The
benchmark PE for the company is 18. What stock price would you consider appropriate? What
if the benchmark PE were 21?
13. Stock Valuation and PS [ LO2] Z Space, Inc., is a new company and currently has negative
earnings. The company’s sales are $2.7 million and there are 175,000 shares outstanding. If
the benchmark price-sales ratio is 4.3, what is your estimate of an appropriate stock price?
What if the price-sales ratio were 3.6?

Intermediate
(Q uestions 14–31) Page 267

14. Stock Valuation [ LO1] Q uinoa Farms just paid a dividend of $2.95 on its stock. The growth
rate in dividends is expected to be a constant 3.4 percent per year indefinitely. Investors
require a return of 15 percent for the first three years, a return of 13 percent for the next three
years, and a return of 11 percent thereafter. What is the current share price?
15. Nonconstant Growth [ LO1] Metallica Bearings, Inc., is a young start-up company. No
dividends will be paid on the stock over the next 9 years because the firm needs to plow back
its earnings to fuel growth. The company will pay a dividend of $14 per share 10 years from
today and will increase the dividend by 3.9 percent per year thereafter. If the required return
on this stock is 11.5 percent, what is the current share price?
16. Nonconstant Dividends [ LO1] Premier, Inc., has an odd dividend policy. The company has
just paid a dividend of $3.75 per share and has announced that it will increase the dividend by
$5 per share for each of the next five years and then never pay another dividend. If you require
a return of 11 percent on the company’s stock, how much will you pay for a share today?
17. Nonconstant Dividends [ LO1] McCabe Corporation is expected to pay the following
dividends over the next four years: $15, $11, $9, and $2.95. Afterward, the company pledges to
maintain a constant 4 percent growth rate in dividends forever. If the required return on the
stock is 10.3 percent, what is the current share price?
18. Supernormal Growth [ LO1] Synovec Co. is growing quickly. Dividends are expected to grow
at a rate of 30 percent for the next three years, with the growth rate falling off to a constant 4
percent thereafter. If the required return is 10 percent, and the company just paid a dividend of
$2.65, what is the current share price?
19. Supernormal Growth [ LO1] Orkazana Corp. is experiencing rapid growth. Dividends are
expected to grow at 25 percent per year during the next three years, 15 percent over the
following year, and then 6 percent per year indefinitely. The required return on this stock is 10
 percent, and the stock currently sells for $86 per share. What is the projected dividend for the
coming year?
20. Negative Growth [ LO1] Antiques R Us is a mature manufacturing firm. The company just
paid a dividend of $12.40, but management expects to reduce the payout by 4 percent per year
indefinitely. If you require a return of 9.5 percent on this stock, what will you pay for a share
today?
21. Finding the Dividend [ LO1] Matterhorn Corporation stock currently sells for $49 per share.
The market requires a return of 11 percent on the firm’s stock. If the company maintains a
constant 3.5 percent growth rate in dividends, what was the most recent dividend per share
paid on the stock?
22. Valuing Preferred Stock [ LO1] E-Eyes.com just issued some new 20/ 20 preferred stock. The
issue will pay an annual dividend of $20 in perpetuity, beginning 20 years from now. If the
market requires a return of 5.4 percent on this investment, how much does a share of preferred
stock cost today?
23. Using Stock Quotes [ LO4] You have found the following stock quote for RJW Enterprises,
Inc., in the financial pages of today’s newspaper. What was the closing price for this stock that
appeared in yesterday’s paper? If the company currently has 25 million shares of stock
outstanding, what was net income for the most recent four quarters?

52-WEEK
STOCK YLD V OL NET
HI LO (DIV ) % PE 100s CLOSE CHG

95.13 63.17 RJW 1.85 2.15 19 17652 ?? .27

24. Two-Stage Dividend Growth Model [ LO1] Impossible Corp. just paid a dividend of $1.93 per
share. The dividends are expected to grow at 24 percent for the next eight years and then level
off to a growth rate of 3.5 percent indefinitely. If the required return is 12 percent, what is the
price of the stock today?
25. Two-Stage Dividend Growth Model [ LO1] Navel County Choppers, Inc., is experiencing rapid
growth. The company expects dividends to grow at 18 percent per year for the next 11 years
before leveling off at 4 percent into perpetuity. The required return on the company’s stock is 11
percent. If the dividend per share just paid was $2.13, what is the stock price?
26. Stock Valuation and PE [ LO2] Meadow Dew Corp. currently has an EPS of $4.05, and the
benchmark PE for the company is 21. Earnings are expected to grow at 4.9 percent per year.
a. What is your estimate of the current stock price?
b. What is the target stock price in one year?
c. Assuming the company pays no dividends, what is the implied return on the company’s stock
over the next year? What does this tell you about the implicit stock return using PE valuation?

27. Stock Valuation and PE [ LO2] You have found the following historical information Page 268
for the Daniela Company over the past four years:

Year 1 Year 2 Year 3 Year 4

Stock price $53.27 $59.48 $62.42 $66.37

EPS 2.35 2.47 2.78 3.04

Earnings are expected to grow at 11 percent for the next year. Using the company’s historical
average PE as a benchmark, what is the target stock price one year from today?
28. Stock Valuation and PE [ LO2] In the previous problem, we assumed that the stock had a
single stock price for the year. However, if you look at stock prices over any year, you will find a
high and low stock price for the year. Instead of a single benchmark PE ratio, we now have a
high and low PE ratio for each year. We can use these ratios to calculate a high and a low stock
price for the next year. Suppose we have the following information on a particular company
over the past four years:

Year 1 Year 2 Year 3 Year 4

High price $62.18 $67.29 $74.18 $78.27

Low price 40.30 43.18 39.27 46.21

EPS 2.35 2.58 2.73 2.89

Earnings are projected to grow at 9 percent over the next year. What are your high and low
target stock prices over the next year?
29. Stock Valuation and PE [ LO2] Regal, Inc., currently has an EPS of $3.25 and an earnings
growth rate of 8 percent. If the benchmark PE ratio is 23, what is the target share price five
years from now?
30. PE and Terminal Stock Price [ LO2] In practice, a common way to value a share of stock
when a company pays dividends is to value the dividends over the next five years or so, then
find the terminal stock price using a benchmark PE ratio. Suppose a company just paid a
dividend of $1.41. The dividends are expected to grow at 13 percent over the next five years. In
five years, the estimated payout ratio is 30 percent and the benchmark PE ratio is 19. What is
the target stock price in five years? What is the stock price today assuming a required return of
11 percent on this stock?
31. Stock Valuation and PE [ LO2] Penguin, Inc., has balance sheet equity of $7.9 million. At the
same time, the income statement shows net income of $832,000. The company paid dividends
of $285,000 and has 245,000 shares of stock outstanding. If the benchmark PE ratio is 16, what
is the target stock price in one year?

CHALLENGE
(Q uestions 32–38)
32. Capital Gains versus Income [ LO1] Consider four different stocks, all of which have a
required return of 12 percent and a most recent dividend of $3.45 per share. Stocks W, X , and