Bond Valuation

Q.1.
5 11 1000
P =  +
t=1 (1.12) (1.12)5

= Rs.110 x PVIFA(12%, 5 years) + Rs.1000 x PVIF (12%, 5 years)

= Rs.110 x 3.352 + Rs.1000 x 0.497
= Rs.(368.72 +497)
=Rs. 865.72

In this case, the number of half-yearly periods are 10, the half-yearly interest payment is 55.

V = 55*PVIFA (6%, 10 years) + Rs.1000 x PVIF (6%, 10 years)

= 55*7.36+1000*.558
=404.80+558
=962.8

2.(i) When the discount rate is 14%

7 120 1000
P =  +
t=1 (1.14) t (1.14)7

= Rs.120 x PVIFA (14%, 7 years) + Rs.1000 x PVIF (14%, 7 years)

= Rs.120 x 4.288 + Rs.1000 x 0.4
= Rs.514.60+ 400
= Rs. 914.6
Note that when the discount rate is more than the coupon rate, the intrinsic value of the bond
is less than the par value of the bond.

(ii) When the discount rate is 12%

7 120 1000
P =  +
t=1 (1.12) t (1.12)7

=Rs.120 x PVIFA (12%, 7 years) + Rs.1000 x PVIF (12%, 7 years)

= Rs. 120*4.5637 + Rs. 1000*0.452349
= Rs.(547.65 + 452.35)
=Rs. 1000
Note that when the discount rate and the coupon rate are the same, the intrinsic value of the
bond is equal to par value of the bond.

(iii) When the discount rate is 12%

7 100 1000
P =  +
t=1 (1.10) t (1.10)7
 =Rs.120 x PVIFA (10%, 7 years) + Rs.1000 x PVIF (10%, 7 years)
= Rs. 120*4.868+ Rs. 1000*0.51316
=Rs(584.21+513.16)
=Rs. 1097.37

Note that when the discount rate is less than the coupon rate, the intrinsic value of the bond
is more than the par value of the bond.

3.
10 140 1000
800 =  +
t=1 (1+r) t (1+r)10

Try r = 18%. The RHS of the above equation is

Rs.140 x PVIFA (18%, 10 years) + Rs.1000 x PVIF (18%, 10 years)

= Rs.140 x 4.494 + Rs.1000 x 0.191 = Rs.820

Try r = 19%. The RHS of the above equation is

Rs.140 x PVIFA(19%, 10 years) + Rs.1000 x PVIF (19%, 10 years)
= Rs.140 x 4.3389 + Rs.1000 x 0.175
= Rs. 607.45+Rs.175
=Rs. 782

Using interpolation in the range 18% and 20% we get:

820 - 800
Yield to maturity = 18% + ----------- x 1%
820 – 782

= 18.52%

Check : Rs.140 x PVIFA(18.52%, 10 years) + Rs.1000 x PVIF (18.52%, 10 years)

=140*4.412+1000*.1828 =800.48

Alternate method:

YTM = 140+[(1000-800)/10]/(1000+800)/2

=160/900

=17.77% (approx.)
4. The post-tax interest and maturity value are calculated below:

Bond A Bond B

* Post-tax interest (C) 12(1 – 0.3) 10 (1 – 0.3)

=Rs.8.4 =Rs.7

* Post-tax maturity value (M) 100 - 100 -

[ (100-70)x 0.1] [ (100 – 60)x 0.1]
=Rs.97 =Rs.96

The post-tax YTM, using the approximate YTM formula is calculated below

8.4 + (97-70)/10
Bond A : Post-tax YTM = -------------------- = 11.1/83.5= 13.29%
(70 + 97)/2

7 + (96 – 60)/6
Bond B : Post-tax YTM = ---------------------- =13/78=16.66%
(60 + 96)/2

Stock Valuation

5. Do = Rs.2.00, g = 0.06, r = 0.12

Po = D1 / (r – g) = Do (1 + g) / (r – g)

= Rs.2.00 (1.06) / (0.12 - 0.06)

= Rs.35.33

Since the growth rate of 6% applies to dividends as well as market price, the
market price at the end of the 2nd year will be:

P2 = Po x (1 + g) 2 = Rs.35.33 (1.06)2
= Rs.39.70

6. Po = D1/ (r – g) = Do(1+g) / (r – g)
Do = Rs.1.50, g = -0.04, Po = Rs.8
So
8 = 1.50 (1- .04) / (r-(-.04)) = 1.44 / (r + .04)

Hence r = 0.14 or 14 per cent

7. Intrinsic value of the equity share (using the 2-stage growth model)

P0 = D1[1-{(1+g1)/1+r)}^n/(r-g1)] +[ {D1(1+g1)^n-1 (1+g2)}/(r-g2)][1/(1+r)^n]

(1.18)6
2.36 x 1 - ----------- 2.36 x (1.18)5 x (1.12)
6
(1.16)
= --------------------------------- + -----------------------------------
0.16 – 0.18 (0.16 – 0.12) x (1.16)6

- 0.10801
= 2.36 x ----------- + 62.05
- 0.02

= Rs.74.80

8. The market price per share of Commonwealth Corporation will be the sum of three
components:

A: Present value of the dividend stream for the first 4 years

B: Present value of the dividend stream for the next 4 years
C: Present value of the market price expected at the end of 8 years.

A= 1.50 (1.12) / (1.14) + 1.50 (1.12)2 / (1.14)2 + 1.50(1.12)3 / (1.14)3 +

+ 1.50 (1.12)4 / (1.14)4

= 1.68/(1.14) + 1.88 / (1.14)2 + 2.11 / (1.14)3 + 2.36 / (1.14)4

= Rs.5.74

B= 2.36(1.08) / (1.14)5 + 2.36 (1.08)2 / (1.14)6 + 2.36 (1.08)3 / (1.14)7 +

+ 2.36 (1.08)4 / (1.14)8

= 2.55 / (1.14)5 + 2.75 / (1.14)6 + 2.97 / (1.14)7 + 3.21 / (1.14)8

= Rs.4.89

C = P8 / (1.14)8

P8 = D9 / (r – g) = 3.21 (1.05)/ (0.14 – 0.05) = Rs.37.45

So

C = Rs.37.45 / (1.14)8 = Rs.13.14

Thus,
Po = A + B + C = 5.74 + 4.89 + 13.14
= Rs.23.77
9. Intrinsic value of the equity share (using the H model)
P0 = D0(1+gn)/r-gn + D0H(ga-gn)/r-gn

4.00 (1.20) 4.00 x 4 x (0.10)

= -------------- + ---------------------
0.18 – 0.10 0.18 – 0.10

= 60 + 20
= Rs.80