This tutorial reviews selected questions from the mid semester exam and includes some follow-up questions. Please make sure that you have worked through these (and thefollow-up) questions and are prepared to discuss them during your tutorial next week. Detailed answers to these questions will made available via the LMS by Thursday evening. If you are unsure of any answer you should check with a tutor during their Zoom consultation or via the Online Tutor.

3. HPL Ltd has recently issued bonds paying a fixed annual coupon of 8% p.a. and maturing in 10 years’ time. The yield to maturity on these bonds is 10% p.a. If market interest rates rise, what is most likely to happen to the price of the bonds?

A.   The bonds will now trade at par.

B.   The bonds will now trade at a discount.

C.   The bonds will now trade at a premium.

D.   One cannot say anything about the price of the bonds without additional information.

Follow-up questions

3.1        How would your answer change if interest rates hadfallen instead of rising?

3.2        How would your answer change if the bond’s coupon rate was 10% and the yield to maturity was 8% and interest rates had risen?

3.3        How would your answer change if the bond’s coupon rate was 10% and the yield to maturity was 8% and interest rates hadfallen instead of rising?

4. XYA Ltd’s earnings per share next year is expected to be $1.50 and the earnings are expected to grow at 5% p.a. for the foreseeable future. Its required rate of return on equity has been estimated to be 9% p.a. The company has a policy of reinvesting 40% of its earnings. The present value of the company's growth opportunities is closest to:

A.  $5.80.

B.   $8.30.

C.   $12.50.

D.  $20.80.

Follow-up question

4.1        Would an increase in the payout ratio (that is, the numerator) necessarily increase the firm’s present value of growth opportunities? Explain.

5. You have been asked by the chief financial officer of your company to estimate what the company’s share price will be at the end of four years from today. Your company has recently paid a dividend of $1.00 which is expected to grow at 5% p.a. over the foreseeable future. If the company’s required rate of return on equity is 10% your price estimate at the end of year 4 will be closest to:

A.  $20.00.

B.   $21.00.

C.   $24.30.

D.  $25.50.

Follow-up questions

5.1        Given the price at the end of year 4, how would you calculate the price today without

using the constant dividend growth model?