Chapter 5

Problem A3: (Bond valuation) General Electric made a coupon payment yesterday on its 6.75% bonds that mature in 8.5 years. If the required return on these bonds is 8% APR, what should be the market price of these bonds?

Solution A3: A bond valuation formula for a bond with semiannual coupon payments is:

B0= CPN21+r22N-1 r21+r22N+ 1,0001+r22N

The semiannual coupon payments in this case will be $33.75 (= one-half of 6.75% of $1,000 = 67.5/2), and the semiannual required return is 4%. Using Equation shown above, the fair price of the bond—the present value of its expected future cash flows—is

B0=(33.75)(1.04)17-1 0.041.0417+ 1,0001.0417

= (33.75) (0.947/0.077) + 513.67 = 415.081 + 513.610 = 928.45

(**It’s assumed that it’s a semi-annual bond with face value of $1000)

Buying this bond for less than $928.45 would be a positive-NPV investment because it is worth more than it costs. Paying more than $928.45 would be a negative-NPV investment. At its fair price of exactly $928.45, buying the bond would be a zero-NPV investment.

Problem A5: (Yield to maturity) New Jersey Lighting has a 7% coupon bond maturing in 17 years. The current market price of the bond is $975. What is the bond’s yield to maturity?

Solution A5: The inputs are B0= 975, CPN/2 = 35.00 (one-half of 7.0% of $1,000), and 2N = 34. Putting these into Equation shown below, we have:

975= 35.001+r22N-1 r21+r22N+ 1,0001+r22N = 3.63% * 2 = 7.26%

(**It’s assumed that it’s a semi-annual bond with face value of $1000)

Problem A11: (Expected return) Northern States Power has a projected dividend of $3.60 next year. The current stock price is $50.50 per share. If the dividend is projected to grow at 3.5% annually, what is the expected return on Northern States stock?

Solution A11:

r=D1P0+g D1 = 3.60, P0 = 50.50, g = 3.5% (0.035)

= 3.60 / 50.50 +0.035 = 0.071 + 0.035 = 0.106 = 10.6% expected return

Problem A16: (Growth rate) Suppose Toshiba has a...