Question

(2. Skylab Technologies issued 10-year bonds yesterday at their par value of $1,000. These bonds pay $60 in interest every six months, and their price has remained at the $1,000 issue price. Skylab's CFO has determined. that the firm needs an additional $2,000,000, and has decided to issue 10-year, $1,000 par value bonds that pay only S40 in interest every six months. If both bonds are to provide investors with the same yield, how many new bonds must Skylab issue to raise $2,000,000? (Ignore the day or two difference between the bonds' issue dates and any bond flotation costs.) USINg a Fnanaal caauiwtr a. 2,596 bonds b. 2,625 bonds c. 2,535 bonds d. 2,571 bonds e. 2,496 bonds 3 Motor Homes Inc. (MHI) is presently enjoying abnormally high growth because of a surge in the demand for motor homes. The company expects earnings and dividends to grow at a rate of 20% for the next 4 years, after which there will be no growth (g 0) in earnings and dividends. The company's last dividend, Do, was $1.50. MHI's beta is 1.5, the market risk premium is 6 % , and the risk-free rate is 4%. What is the current price of the Yusing a financial calatar common stock? a. $21.66 b. $19.63 c. $23.57 d. $25.87 e. $17.51

Answer 1

Solution for 2)

Given: Coupon payment of old bonds= $60 in every 6 months.

Annual coupon payment = $120

Current Yield-to-maturity = Coupon payment/Bond price =$120/$1000 = 0.12 or 12%

Yield-to-maturity on new bonds = yield-to-maturity on old bonds = 12%

Given : New bond maturity in 10 years, coupon payment is $40 biannually. Par value of new bond = $1,000

To find out how many bonds need to be issued, we have to find out the price of the new bond.

Input known variables in a financial calculator. Current value of the bond comes at $770.60

Now, we can calculate how many bonds worth $770.60 should be issued to raise $2,000,000. It is simply $2,000,000/770.6= 2595.3 or 2596 bonds. Option A is the right answer.

Solution for 3.

Note: This calculation can be done using a simple calculator as well

First, we have to calculate the expected rate of return using CAPM formula

Expected Rate of return = Risk-free rate of return + (Beta of the stock * Market risk premium)

Hence, Expected rate of return = 4 + (1.5 *6) = 13%

Now, we can find out the price of the stock using the two-stage dividend discount model

Last dividend (D0) was $1.5 per share. dividend is expected to grow at 20% each year.

Hence, D1 = $1.5 *1.20 = $1.8, D2= $18*1.20= $2.16, D3= $21.6*1.20 = $2.59, D4= $25.92*1.20 = $3.111

The next step is to bring these values in present terms. We can calculate that using the expected rate of return of 13%

Present value of D1= $1.8/1.13= $1.59. Present value of D2 = $2.16/(1.13^2) = $1.69

Present value of D3 = $2.59/(1.13^3) = $1.79 Finally, Present value of D4 = $3.11/(1.13^4) = $1.91

At this juncture, we need to figure out the terminal value at the end of the high-growth period, and then discount that value back to present.

To do so, we will use formula (D4(1+G)/(R-G))/(1+R)^4

where D4 is the dividend in the fourth year

G is the dividend growth in the second phase. In this case it is 0%.

R = The expected rate of return = 13%

= (($3.11(1 +0.0)/(0.13-0.00)/(1+0.13)^4 = $14.67. This is the present value of the terminal value at year four.

The last step is to add up the present values of the dividends in the early-growth stage and the present value of the terminal value

Current price of the stock= $1.59+$1.69+$1.79+$1.91+$14.67 = $21.65

Hence, the correct answer is Option A