Question

Question 2 PepsiCo. Inc. shares trade on NasdaqGS under the ticker symbol PEP. In 2019, analysts forecasted a five-year growth rate of 8% when the current dividend was(Dy=$ 2.3).Suppose PepsiCo.Inc. grows at 8% for five years and then at 5% thereafter. Assuming an 7% discount rate, what is the present value of the PEP's share? The current price is 134.06 (November 18.2019), would you buy this stock? Explain your answer Question3 You decide you will invest in the following bonds. It is November 19, 2019 and you're considering bonds issued by Company 1 and Company 2 with the following properties. Bond (1) Bond (2) Years to maturity Coupon rate 8% Yield to maturity 7% Market Price 950 1050 a) For each bond explain why it is selling at a premium or a discount b) As per the most recent forecasts, interest rates are expected to fall in the future. What will happen to the price of each bond? Which of these bonds has the largest price change? Explain 7% Question 4 You have received the following information for Bond X, the annual coupon rate is 11%, the bond was issued in 2015 and will mature in ten years. The current market price is $933. What is the yield to maturity and the current yield of the bond? Which yield will you use to evaluate the bond and why? GOOD LUCK

if you are not given the par value of the bond, then assume it to be 1000.

Answer 1

Answer to Question 2:

Particulars	Dividend Value	Discount Factor @ 7%	Present Value of Dividends
D1	$2.81	0.9346	$2.62
D2	$3.03	0.8734	$2.65
D3	$3.28	0.8163	$2.67
D4	$3.54	0.7629	$2.70
D5	$3.82	0.7130	$2.72
D6 to perpetuity	$ 200.56	0.7130	$ 143.00
			$ 156.37

D1 is (D0 x 1.08), D2 is (D1 x 1.08)...
D6 to perpetuity is (D5 x 1.05) / (7% - 5%) = ($3.82 x 1.05) / 2% = $200.56.

Therefore the present value of one share of PEP is $156.37.
If current price is anything less than $156.37, it is profitable to buy the stock. Hence, if the price is $134.06, it is beneficial to buy the stock; it will have a positive net present value.

Answer to Question 3:
(a):

• Value of Bond (1) is the present value of all future cash flows:

• Year	Cash Flow	Discount Factor	Present Value
  1	$          60.00	0.9346	$    56.07
  2	$          60.00	0.8734	$    52.41
  3	$          60.00	0.8163	$    48.98
  4	$          60.00	0.7629	$    45.77
  5	$    1,060.00	0.7130	$ 755.77
  			$ 959.00

• As the present value is $959 and the market price is $950, Bond (1) is selling at a discount.
• Value of Bond (2) is the present value of all future cash flows:

• Year	Cash Flow	Discount Factor	Present Value
  1	$           80.00	0.9346	$          74.77
  2	$           80.00	0.8734	$          69.88
  3	$           80.00	0.8163	$          65.30
  4	$           80.00	0.7629	$          61.03
  5	$           80.00	0.7130	$          57.04
  6	$           80.00	0.6663	$          53.31
  7	$     1,080.00	0.6227	$       672.57
  			$    1,053.89

• As the present value is $1,053.89 and the market price is $1,050, Bond (2) is selling at a discount, too.

(b):

• If interest rates fall, the prices of bonds will increase. This is because the demand for bonds will increase when the interest rates fall (logic: people will want to invest in Bonds more than keep as deposits in banks as the bank interests fell). And Bond (2) will have the largest price change because it has a higher coupon rate.

Answer to Question 4:

• Yield to maturity without considering time value = $110 / $1,000 = 11% (assuming it was issued at $1,000 itself, without discount or premium).
• Yield to maturity after considering time value = IRR of the investment which is same as 11% if it was issued at $1,000 itself. This assumption is taken in the light of no other data available. However, it is possible to consider issue price as $933 and that it was issued today (2019) or it is possible to rework the value of $933 back to 2015. However this seems far fetched. So we better stick with the first assumption.
• Current yield = Coupon amount / Market price = $110 / $933 = 11.78%
• To evaluate the bond today, it is better to use Current Yield as it is the return based on current prices, whereas YTM is the rate based on the entire duration (until maturity).

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