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Hello John
There are 3 questions from the MC exams that I got incorrect. I tried doing it over but still I’m not getting an answer close to what was provided. I am not sure what I’m doing wrong. Can you kindly provide the workings for the following:
#1-RI Co has in issue 6% redeemable bonds, quoted at 120% ex int.
What is the interest yield and redemption yield?#2-R plc has in issue $400,000 8% bonds, redeemable in 5 years time at a premium of 10%.
Investors require a return of 12% p.a..The rate of corporation tax is 35%.What is the total market value of the debt in issue?#3-A company has just paid a dividend of $0.23 per share.
Shareholders are expecting the dividend to remain at $0.23 per share next year, but to increase at an average rate of 3% per annum thereafter.
Shareholder required rate of return is 12%, and the rate of corporation tax is 25%.
What will be the current market value per share (to the nearest cent)?Also this question:
#4-A company has just paid a dividend of $0.23 per share.
Shareholders are expecting the dividend to remain at $0.23 per share next year, but to increase at an average rate of 3% per annum thereafter.
Shareholder required rate of return is 12%, and the rate of corporation tax is 25%.
What will be the current market value per share (to the nearest cent)?Question 1:
The interest yield is 6/120 = 5%
You cannot be asked to calculate the redemption yield, but you are expected to realise the it will be less than the interest yield (because the redemption is less than the current market value). Only one of the choices has the interest yield at 5% and the redemption yield lower than 5%
Question 2:
The market value is the present value of the future receipts (32,000 a year for 5 years; and 440,000 in 5 years time) discounted at 12% (the investors required return).
(Corporation tax is not relevant to the investors, and it is the investors who fix the market value – see the lectures on the valuation of securities)
Question 3:
The dividend valuation formula is MV = (Do x (1 + g)) / (Re – g).
However strictly the formula should be D1 / (Re – g) , where D1 is the dividend in 1 years time. Usually it is no problem – the dividend in 1 years time is the current dividend with a years growth – Do(1+g).
However in this question the dividend in 1 year is 23c, not 23c plus growth.
So the MV = 23 / (0.12 – 0.03) = 256c ($2.56)
(It may seem a bit unfair but the examiner has asked this sort of problem quite often in recent years)
Question 4:
Errrr……unless I am missing something, it is the same as your question 3 🙂
Dear John,
Can you please provide the calculation of below question
R plc has in issue $400,000 8% bonds, redeemable in 5 years time at a premium of 10%.
Investors require a return of 12% p.a..The rate of corporation tax is 35%.What is the total market value of the debt in issue?Many Thanks
The market value is the present value of future receipts, discounted at the investors required rate of return.
The future receipts are interest of 32,000 a year for 5 years. At 12%, these discount to 115,360.
In addition there is the repayment of 440,000 in 5 years time. At 12% this discounts to 249,480So the total market value = 115,360 + 249,480 = 364,840
(Tax is not relevant because it is investors who fix the market value and company tax does not affect their receipts)
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