Bonds Valuation
Perpetual Bond – no maturity date
1. ABC company is considering to issue a Rs. 1,000 10% bond on January 1, 2020. If the
required rate of return is 12%, at what price should the company issue the bond/ good buy
or investment/ If the bond being issued for Rs. 600, is this a good investment.
Par rate and coupon rate remains fixed. 𝐼 = 𝑃𝑅 ∗ 𝐶𝑅
𝐼
𝑉𝑎𝑙𝑢𝑒 =
𝐾𝑑
100
𝑉𝑎𝑙𝑢𝑒 =
0.12
𝑉𝑎𝑙𝑢𝑒 = 833.33
If company is buying at 900 then its overvalued and not a good buy and vice versa at 800.
2. ABC company is considering to issue Rs 1000 10% bonds on January 1, 2020. If the bond was
originally issued at January 3, 2018 and is being traded in the market for Rs. 600. What is
the require rate of return?
𝐼
𝑉𝑎𝑙𝑢𝑒 =
𝐾𝑑
100
600 =
𝑥
𝐾𝑑 = 0.167
Zero Coupon Bond
Maturity value (MV) always equals to par value unless otherwise stated.
N is remaining years in maturity.
1. ABC company is considering to issue Rs 1000 10% bonds on January 1, 2020. The bond is
expected to mature on December 31, 2025 the require rate of return is 12%. At what price
should the company issue the bond?
𝑀𝑉
𝑉𝑎𝑙𝑢𝑒 =
(1 + 𝐾𝑑 )𝑛
1000
𝑉𝑎𝑙𝑢𝑒 =
(1 + 0.12)6
𝑉𝑎𝑙𝑢𝑒 = 506.63
2. ABC company is considering to invest in a Rs 1000 bonds on January 1, 2020. The bond was
originally issued on January 1, 2018 and expected to mature December 31, 2026. If the
required rate of return is 12% and the bond is being traded at Rs 650 in the market. Is this a
good buy?
𝑀𝑉
𝑉𝑎𝑙𝑢𝑒 =
(1 + 𝐾𝑑 )𝑛
1000
𝑉𝑎𝑙𝑢𝑒 =
(1 + 0.12)7
𝑉𝑎𝑙𝑢𝑒 = 452.33
3. ABC company is considering to invest in a Rs 1000 bonds on January 1, 2020. The bond
expected to mature December 31, 2030 and is being traded in the market for rupees 400.
What is the required rate of return?
𝑀𝑉
𝑉𝑎𝑙𝑢𝑒 =
(1 + 𝐾𝑑 )𝑛
1000
400 =
(1 + 𝑥)11
11 1000
1+𝑥 = √
400
𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑟𝑎𝑡𝑒 = 8.69%
Non – Zero Coupon Bond
1. ABC company is considering to issue Rs 1000 10% bonds on January 1, 2020. The bond is
expected to mature on December 31, 2029. If the required rate of return is 12%. At what
price should the company issue the bond?
𝑀𝑉
𝑉𝑎𝑙𝑢𝑒 = 𝐼[𝑃𝑉𝐼𝐹𝐴]
(1 + 𝐾𝑑 )𝑛
1
(1 − ) 𝑀𝑉
(1 + 𝐾𝑑 )𝑛
𝑉𝑎𝑙𝑢𝑒 = 𝐼 [ ]+
𝐾𝑑 (1 + 𝐾𝑑 )𝑛
1
(1 − ) 1000
(1 + 0.12)10
𝑉𝑎𝑙𝑢𝑒 = 100 [ ]+ = 887
0.12 (1 + 0.12)10
2. ABC company is considering to issue Rs 1000 10% bonds on January 1, 2020. The bond is
expected to mature on December 31, 2025 and the market price is 720. Find the required
rate of return.
1
(1 − ) 𝑀𝑉
(1 + 𝐾𝑑 )𝑛
𝑉𝑎𝑙𝑢𝑒 = 𝐼 [ ]+
𝐾𝑑 (1 + 𝐾𝑑 )𝑛
1
(1 − ) 1000
(1 + 𝑥)5
720 = 100 [ ]+
𝑥 (1 + 𝑥)5
𝐴𝑇 19% = 724.8
𝐴𝑇 20% = 700.9
(𝑽𝒂𝒍𝒖𝒆 @ 𝒍𝒐𝒘𝒆𝒓 𝒓𝒂𝒕𝒆 − 𝒓𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝒗𝒂𝒍𝒖𝒆)
𝑰𝒏𝒕𝒆𝒓𝒑𝒐𝒍𝒂𝒕𝒊𝒐𝒏 = 𝒍𝒐𝒘𝒆𝒓 𝒓𝒂𝒕𝒆 + × 𝒅𝒊𝒇𝒇𝒆𝒓𝒆𝒏𝒄𝒆 𝒊𝒏 𝒓𝒂𝒕𝒆
((𝑽𝒂𝒍𝒖𝒆 @ 𝒍𝒐𝒘𝒆𝒓 𝒓𝒂𝒕𝒆 − 𝑽𝒂𝒍𝒖𝒆 @ 𝒉𝒊𝒈𝒉𝒆𝒓 𝒓𝒂𝒕𝒆)
(𝟕𝟐𝟒. 𝟖 − 𝟕𝟐𝟎)
𝑰𝒏𝒕𝒆𝒓𝒑𝒐𝒍𝒂𝒕𝒊𝒐𝒏 = 𝟎. 𝟏𝟏 + × 𝟎. 𝟎𝟏
(𝟕𝟐𝟒. 𝟖 − 𝟕𝟎𝟎. 𝟗)
𝑰𝒏𝒕𝒆𝒓𝒑𝒐𝒍𝒂𝒕𝒊𝒐𝒏 = 𝟐𝟎. 𝟐%– so the required rate of return will 20,2%.
Stock Valuation
Preference Stock
1. ABC Company is considering to issue a rupees 20 stock at January 1, 2020. If the required return is
12% at what price company should issue the share.
𝐷𝑝
Value =
𝐾𝑃
𝟐𝟎∗𝟏𝟎%
Value = = 𝟏𝟔. 𝟔𝟕
𝟎.𝟏𝟐
2. ABC company is considering to issue a rupees 20 at 10% preference stock on January 1, 2020. The
stock may be called back on December 31, 2025 at the premium of 5%. Required rate of return 12%
𝑐𝑎𝑙𝑙 𝑣𝑎𝑙𝑢𝑒
Value = Dp [Py1FA] +
(1+𝑘𝑝)𝑛
1
1− 21
(1.12)6
Value = 2 ( ) + (1+0.12)6
0.12
Value = 18.86
3. ABC company is considering to invest in a rupees 20 at 10% preference stock on January 1, 2020.
The stock was originally issued on January 1, 2018 and may be called back on December 31, 2027. If
the required rate of return is 13% and the call value is 22.5, and its been traded in the market for
rupees 17. Is this stock a buy.
1
1− 22.5
(1.+0.13)8
Value = 2 ( ) + (1+0.13)8
0.13
Value = 18.06
4. ABC company is considering to invest in a rupees 20 10% preference stock on January 1, 2020. The
preferred stock is being traded in the market for rupees 18 and may be called back on December 31,
2030 at a premium of 5%. What is the required rate of return?
1
1−(1.+𝑘𝑝) 11 21
18 = 2 ( ) + (1+𝑘𝑝)11
𝑘𝑝
At 10% required return = 20.35
At 11% required return = 19.08
At 12% required return = 17.91
(𝑽𝒂𝒍𝒖𝒆 @ 𝒍𝒐𝒘𝒆𝒓 𝒓𝒂𝒕𝒆 − 𝒓𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝒗𝒂𝒍𝒖𝒆)
𝑰𝒏𝒕𝒆𝒓𝒑𝒐𝒍𝒂𝒕𝒊𝒐𝒏 = 𝒍𝒐𝒘𝒆𝒓 𝒓𝒂𝒕𝒆 + × 𝒅𝒊𝒇𝒇𝒆𝒓𝒆𝒏𝒄𝒆 𝒊𝒏 𝒓𝒂𝒕𝒆
((𝑽𝒂𝒍𝒖𝒆 @ 𝒍𝒐𝒘𝒆𝒓 𝒓𝒂𝒕𝒆 − 𝑽𝒂𝒍𝒖𝒆 @ 𝒉𝒊𝒈𝒉𝒆𝒓 𝒓𝒂𝒕𝒆)
(𝟏𝟗. 𝟎𝟖 − 𝟏𝟖)
𝑰𝒏𝒕𝒆𝒓𝒑𝒐𝒍𝒂𝒕𝒊𝒐𝒏 = 𝟎. 𝟏𝟏 + × 𝟎. 𝟏
(𝟏𝟗. 𝟎𝟖 − 𝟏𝟕. 𝟗𝟏)
𝑰𝒏𝒕𝒆𝒓𝒑𝒐𝒍𝒂𝒕𝒊𝒐𝒏 = 𝟏𝟏. 𝟗%– so the required rate of return will 11.9%.
Common Stock
If the question says just declared or just paid, means it is current dividend. (𝐷0 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑)
If the question says expected to pay or expected to be declared, so dividend, that will be next year
dividend. (𝐷1 − 𝑛𝑒𝑥𝑡 𝑦𝑒𝑎𝑟 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑)
𝐷1 = 𝐷0 (1 + 𝑔)1 – where g is growth (growth of dividends) and is constant
If there is no mention of growth, then dividend will be constant.
1. ABC company has just declared 2 rupees dividend, if the required rate of return is 12%. What value
will you assign to stock.
𝐷1
𝑉𝑎𝑙𝑢𝑒 =
𝑘𝑒
𝐷0 (1 + 𝑔)
𝑉𝑎𝑙𝑢𝑒 =
𝑘𝑒
2(1 + 0)
𝑉𝑎𝑙𝑢𝑒 =
0.12
𝑽𝒂𝒍𝒖𝒆 = 𝟏𝟔. 𝟔𝟕
2. ABC company has just declared a 2 rupees dividend, which will grow at 3% forever. If the required of
rate of return is 8%. At what price is this stock a good buy?
𝐷1
𝑉𝑎𝑙𝑢𝑒 =
𝑘𝑒 − 𝑔
𝐷0 (1 + 𝑔)
𝑉𝑎𝑙𝑢𝑒 =
𝑘𝑒 − 𝑔
2(1 + 0.03)
𝑉𝑎𝑙𝑢𝑒 =
0.08 − 0.03
𝑽𝒂𝒍𝒖𝒆 = 𝟒𝟏. 𝟐
3. ABC company is expected to pay a 2 rupees dividend, which will grow at 3% forever. If the required
of rate of return is 8%. At what price is this stock a good buy? (D1 given)
𝐷1
𝑉𝑎𝑙𝑢𝑒 =
𝑘𝑒 − 𝑔
2
𝑉𝑎𝑙𝑢𝑒 =
0.08 − 0.03
𝑽𝒂𝒍𝒖𝒆 = 𝟒𝟎
4. ABC company has just declared a 2 rupees dividend, which is expected to grow at 3% forever. If the
share is being traded in the market for rupees 20. What is the required of rate of return?
𝐷1
𝑉𝑎𝑙𝑢𝑒 =
𝑘𝑒 − 𝑔
2(1 + 0.03)
20 =
𝑘𝑒 − 0.03
𝒓𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏 = 13.3%
Cost of Capital (cost of raising capital)
If capital is raised through debt – it’s called cost of debt (Kd)
If capital is raised through preferred stock – it’s called cost of preferred equity (Kp)
If capital is raised through common stock – it’s called cost of common equity (Ke/Kc)
Anything which is cost for company, it’s returns for investor.
Always take market price to find weight.
Question:
ABC company is considering to invest in a project worth Rs. 10 million. The company plans to finance the
project by issuing:
• 4,000 Rs.1,000 10% bonds for Rs. 950.
• 100,000 Rs 20 10% preferred stock for Rs. 18
• Rest will be financed by common stock Rs. 10 and the company is expected to pay Rs. 2.5
dividend which will grow at 3% forever.
• The company falls under 35% tax bracket
What is project’s weighted average cost of capital (WACC)?
𝑾𝑨𝑪𝑪 = (𝑾𝑫)(𝑲𝒅)(𝟏 − 𝒕) + (𝑾𝑷)(𝑲𝒑) + (𝑾𝑬)(𝑲𝒆)
Bonds (4,000*950) 3.8 million 38%
PS (100,000*18) 1.8 million 18%
CS (440,000*10) 4.4 million 44%
Project Cost 10 million 100%
Bonds (Kd):
𝐼
𝑉𝑎𝑙𝑢𝑒 =
𝐾𝑑
1,000 ∗ 10%
950 =
𝐾𝑑
𝒓𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏 (𝑲𝒅) = 10.5%
Preferred Stock (Kp):
𝐷𝑝
𝑉𝑎𝑙𝑢𝑒 =
𝐾𝑝
20 ∗ 10%
18 =
𝐾𝑝
𝒓𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏 (𝑲𝒑) = 𝟏𝟏. 𝟏%
Common Stock (Ke):
𝐷1
𝑉𝑎𝑙𝑢𝑒 =
𝑘𝑒 − 𝑔
𝐷0 (1 + 𝑔)
𝑉𝑎𝑙𝑢𝑒 =
𝑘𝑒 − 𝑔
2.5(1 + 0.03)
10 =
𝐾𝑒 − 0.03
𝒓𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏 (𝑲𝒑) = 𝟐𝟖. 𝟕𝟓%
𝑊𝐴𝐶𝐶 = (𝑊𝐷)(𝐾𝑑)(1 − 𝑡) + (𝑊𝑃)(𝐾𝑝) + (𝑊𝐸)(𝐾𝑒)
𝑊𝐴𝐶𝐶 = (0.38)(0.105)(1 − 0.35) + (0.18)(0.11) + (0.44)(0.28)
𝑾𝑨𝑪𝑪 = 𝟏𝟔. 𝟗%
