Question

2. Consider the information in Tables 1 and 2 Table 1 Market Capitalization Rate Stock iStock Price Dividend (Div) Return onPayout RatioGrowth Rate (PR) Equity (ROE) 12 14 16 10% 20% 30% 20% 10% 100% 50% 100% 0% 3 175 0% Table 2 Bond i Par Value Coupon Frequend Yearl earl Bond Maturity Yield to Maturit 6.5% 7.5% Coupon Rate 1,000 1,000 10% 5% 4 Years 3 Years (a) Consider Table 1. Complete the blanks in Table 1 (b) Consider Table 1. Now suppose that Firm 3 (Stock 3) also repurchases shares to the value of 10 per share. What is the value of stock 3 under total payout valuation? (c) Consider Table 1 . Assume now that the payout ratio (PR) for stock 1 is 90%. Calculate the stock price, growth rate, and present value of growth opportunity (PVGO) for stock1 (d) Consider Table 2. Calculate the present value of bonds 1 and 2

Answer 1

(a) Formula: P=D/Ke-g; P=stock price, D= Dividend, g= growth, ke= capitalisation rate

Po	D	ke	g
120(12/10%)	12	10	0
140	14	20	10
175	16	9.142857	0

(b) In case the company repurchases its shares at 10, it won't affect the price of share as the payout is already 100%.

(c)

payout	90%
retetnion	10%
ROE	30
growth(retention*ROE)	3

Now using the same formula as in (a)

p0	D	ke	g
171.4286	12	10	3

NPVGO: Stock price*(Earnings rate-growth rate)/(capitalisation rate-earnings rate)

Earnings rate=17.5% growth rate = 3% (as above), Stock price= 171.426. NPVGO=(331.43)

(d)

Par value	1000	1000
Coupon rate	10	5
Annual Coupon Payment	100	50
Number Payments( Bond Maturity)	4	3
YTM	6.50%	7.50%
Present Value Paid at Maturity	$777.32	$804.96
Present Value of Interest Payments	$342.58	$130.03
Present Value of Bond	$1,119.90	$934.99

Formula used :

Present Value Paid at Maturity = Face Value / (Market Rate/ 100) ^ Number Payments

Present Value of Interest Payments = Payment Value * (1 - (Market Rate / 100) ^ -Number Payments) / Number Payments)

Present Value of Bond = Present Value Paid at Maturity + Present Value of Interest Payments