Question

Marconi Inc. is a large corporation that produces specialized high-end automobile parts. You have obtained the following information from the company's financial statements: 5-year bond issued May 1, 2017 5-year bond issued November 1, 2018 Long Term Debt Bond A Bond B Total Long Term Debt Equity Preferred Shares Preferred Shares A 2.000.000 1.500.000 3.500.000 500.000 Series A-5 years to maturity 7% dividend – $75 par issued on November 1, 2017 Series B -no maturity paying a $5.25 dividend 1.000.000 Preferred Shares B Total Preferred Shares Common Equity Common Shares Retained Earnings Total Common Equity Total Equity 200,000 common shares authorized, issued and 2,000,000 outstanding 500.000 2.500.000 3.500.000 Notes to the financials: All bonds have face value of $1,000. Bond A - was issued at a quoted price of 95.0 and pays its 6 percent coupon on May 1 and November 1 every year. Bond B - was issued at par and pays its 5% coupon semi-annually. The firm is expecting the earnings to be $3,000,00 for 2019 and the dividend for November 1, 2019 of $1.20 per share was just paid. Assume today is Nov 1, 2019. a) If the market interest rate for bonds that are identical to bond A is 4.5% (APR). calculate the price of bond A in the market today. Show your work! (4 marks) b) If an investor bought bond A when it was first issued in May 2017 and sold the bond today, what is their effective annual holding period return? Show your work! (4 marks) c) Calculate the current yield for bond A. Show your work! (2 mark) d) Preferred shares Series B are quoted in the market to provide a 6 percent rate of return. Calculate the market price for the series B preferred shares. Show your work! (2 marks) e) During the board meeting, the members of the board were discussing some investing opportunities that would result in dividend growth of 20 percent for the next 5 years and then a growth 1.8% thereafter. Assuming the required rate of return for the

Answer 1

The solution to the part a)

The price of a bond is the sum total of present values of all coupon payments and present value of maturity value.

Further, the cash flows value and the discount rate should always be consistent i.e. if cash flows are received semiannually, time interval and required rate of return is also compounded semiannually,

Thus,

Coupon rate will be 6%/2 = 3%

YTM will be 4.50% / 2 = 2.25%

And; years to maturity will be 2.5years * 2 = 5 years

Face Value of Bond A $ 1000

Bond A price as on Nov 01, 2019 = PV of all coupon payments + PV of maturity value

PV of all coupon payments = (coupon payments) * cumulative discount factor for 5 years at the YTM

= (Face Value * Coupon rate ) * ( (1-1/(1+YTM)^N) / YTM )

= $ 30.00 * ((1- 1/(1+2.25%)⁵)/2.25%)

= $ 30.00 * 4.6795

= $ 140.38

PV of maturity value = Face value * discount factor for 5^th year at the YTM

= $ 1000 * (1/(1+YTM)^N)

= $ 1000 * (1/(1+2.25%)⁵)

= $ 1000 * 0.8947

= $ 894.71

Bond A price as on Nov 01, 2019= PV of all coupon payments + PV of maturity value

= $ 140.38 + $ 894,71 = $ 1035.09

The solution to the part b)

Holding Period Return on Nov 01, 2019 = [Coupons + (Bond Price as on Nov 01, 2019  - Quoted Price)] / Quoted Price) * 100

= [($ 1000 * 3% * 2.5 years * 2) + ( $ 1035.09 - $ 95.00 )] / $ 95.00 * 100

=[ $ 150.00 + $ 9.8957 ] * 100

= 15989%

Annualised HPR = (HPR+1)^1/n - 1

= (15989%+1)^1/2.5 - 1

= 6336%

The solution to the part c)

Current Yield = Annual Coupons / Current Bond Price

= $ 1000 * 6% / $ 1035.09

= 5.80%

The solution to the part d)

Since the Series B preference stock has no maturity, its dividend will be paid till perpetuity.

Hence the market price of the Preferred share series B will be the present value of the dividends at the market rate of return

Series B Preferred Share Price = [ Preference Dividend / Required Market rate of return ]

    = $ 5.25 / 6%

Market price = $ 87.50