1)
a) The formula for calculating the value of the bond is;
Value of the bond = Present value (PV) of bond interest + the maturity value of
the bond at the market interest rate.
Bond value = $1000
Interest rate = 4%
Interest payments = $50
PV of interest payments = $50 * PVAF 4% 10 years
= $50 * 8.1108
= $405.54
Value of Bond = $675.5 + $405.54 = $1081.04
PV of maturity value = $1000 * PVF 4% 10 year
= $1000 * 0.6755
= $675.5
b) If the bond pays no coupon payment, then, its value of bond will be less. The
value of the bond will be PV of its maturity value which is $675.5.
c) If the inflation rate rises above the coupon rate of the bond, the bond's value will
drop below $1000. As a result, the bond's face value will be less than its face
value since the bond's current value will decline owing to increased market
interest rates.
d) If the interest rate falls, the bond's value rises. If the interest rate is 2%, the bond's
value is as follows:
STOCK AND BOND VALUATION CASE 3
Bond Value = $1000
Interest rate = 2%
Interest payments = $50
PV of maturity value = $1000 * PVF 2% 10 year
= $1000 * 0.8203
= $820.3
PV of interest payments = $50 * PVAF 2% 10 years
= $50 * 8.9825
= $449.125
Value of Bond = $820.3 + 449.125 = $1269.425
or approximately $1269.43
2)
a) According to the dividend discount model, the value of each share may be
estimated using its dividend, needed rate of return, and dividend growth rate
(Bodenhorn, 1984). Share today's value (V0) = Next dividend expected to be paid
(D1) divided by (required rate of return (k) – growth rate in dividend (g))
Share today's value (V0) = $1 / (8% – 0%)
Share today's value (V0) = $1 / 8%
Share today's value (V0) = $12.50
b) The value of each share = $1/ (.08-.04)
= $25
c) The new value of each share = $1/ (.08-.06)
= $50
STOCK AND BOND VALUATION CASE 4
3)
a) To calculate the present value of future cash flow, we used the formula;
FV (1 + r) n (Parker, 1993), where,
FV = fair value.
r = rate of return.
n = number of periods.
Therefore, the present value of the future cash flows of would be;
= 669,763 (1 + 0.03) 5
= 17,245,716.59
STOCK AND BOND VALUATION CASE 5
b) Value of share = Market value ÷ Number of common Shares
Value of share = $10,000,000 ÷ $200,000
Value of share = $50
Therefore, the value of each share is $50
c) The answers to a) and b) above will change depending on the new discount rate.
The answers will be a) -$341,116.17, and b) -$1.71
4)
a) In this case, bondholders are required to liquidate since they have priority over
shareholders in the liquidation (Lee, 2018). The liquidation is preferred by half of
the stockholders, while the remaining shareholders are opposed. Because
STOCK AND BOND VALUATION CASE 6
bondholders are unable to alter the CEO by voting, stockholders would need a
vote result of 50% or higher to replace the person in the CEO role.
b) Because bondholders have priority over shareholders, they would get $50000000,
with the balance ten million dollars going to the bondholders.
c) In this case, the bondholders still have precedence; this means that the
bondholders will receive the whole fifty million dollars, while the remaining ten
million dollars are distributed among the stockholders. Consequently, the
investors would receive nothing.
STOCK AND BOND VALUATION CASE 7
References
Bodenhorn, D. (1984). Balance sheet items as the present value of future cash flows. Journal of
Business Finance & Accounting, 11(4), 493-510.
Parker, G. A. R. Y. (1993). Distribution of the present value of future cash flows. In Proceedings
of the 3rd AFIR International Colloquium, Rome (pp. 831-843).
Lee, M. (2018, May 22). What happens to a company's stock when it goes bankrupt? Retrieved
from https://www.investopedia.com/ask/answers/06/bankruptpublicfirm.asp.