# Module 2 – Case

## Stock and Bond Valuation

### Assignment Overview

Before starting on this assignment, make sure to thoroughly review

the required background materials. This assignment will require you to

use the various discounted cash flow methods and dividend models to make

computations. In addition to knowing the computational steps involved

in stock and bond valuation, make sure you also understand the basic

concepts.

Submit your answers as a Word document. Make sure to show your work

for all quantitative questions, and make sure to fully explain your

answers using references to the background readings for any conceptual

questions. Questions 1 and 3 will require Excel, so submit an Excel file

that shows your computational steps as a separate file in addition to

your Word file. Question 4 is purely conceptual, no computations are

necessary but make sure to apply and reference concepts from the

required readings in your answers to each of the scenarios.

### Case Assignment

- Suppose you buy a bond that will pay $1000 in ten years along with

an annual coupon payment of $50 and the interest rate is 4%. Answer the

following questions:- What is the value of this bond?
- Now suppose the bond has no coupon payments (it is a “zero coupon”

bond) but still pays $1000 in ten years. What is the value of this bond? - What would happen to the value of the bond if the inflation rate unexpectedly goes up? What the bond value increase or decrease?
- Now suppose the bond still pays an annual coupon of $50 but the interest rate drops to 2%. What is the new value of this bond?

- The XYZ Corporation pays a dividend of $1 for each share and its required rate of return is 8%. Answer the following questions:
- Assuming zero growth in dividends, what is the value of each share?
- Now assume a 4% annual growth rate in the dividend paid. What is the value of each share?
- Assume the growth rate is still 4%, but the required rate of return drops to 6%. What is the new value of each share?

- Acme Medical Corp. is expecting the cash flows from 2018-2022 in the

table below. After 2022 it is expecting growth in cash flow at an

annual rate of 3%. The firm has determined that its weighted average

cost of capital (discount rate) is 7%. Using the table below calculate

the following:- What is the present value of Acme’s future cash flows using the discounted cash flow model?
- If the firm has 200,000 common shares outstanding, zero preferred

shares, and debt with a market value of $10,000,000 what would be the

value of each share? - Now suppose the discount rate increases to 10%. How would your answers to a) and b) above change based on the new discount rate?

Year |
Cash flow |

2018 |
500,000 |

2019 |
550,000 |

2020 |
620,000 |

2021 |
700,000 |

2022 |
800,000 |

- Suppose the Alpha Manufacturing Corporation is experiencing extreme

financial difficulties and is considering bankruptcy. Its shareholders

are currently almost equally divided about whether or not the company

should go bankrupt, with one outspoken faction pushing for bankruptcy

and the other strongly opposing it. They have $50 million in debt all in

the form of bonds, and bondholders are pretty well united in that they

want the firm to declare bankruptcy.- The CEO announces that he is leaning against bankruptcy. This means

one faction of shareholders is happy, but another faction of

shareholders is very upset and the bondholders are also unhappy. Can the

unhappy faction of shareholders team up with the bondholders to vote

out the CEO? Explain your reasoning using references from the background

readings. - Suppose Alpha ends up declaring bankruptcy. They do not have any

cash in the bank but they own $60 million worth of real estate. They

only have one type of shareholder—common shareholders. If they sell the

real estate, how much of this will bondholders get and how much with

shareholders get? Explain your reasoning using references from the

background readings. - Now suppose that Alpha has two classes of shareholders—common

shareholders and preferred shareholders. Preferred shareholders are owed

$20 million in dividends that have been unpaid in the last two years.

If Alpha goes bankrupt and sells its $60 million worth of real estate,

how much will bondholders get, how much will common shareholders get,

and how much will preferred shareholders get? Explain your reasoning

using references from the background readings.

- The CEO announces that he is leaning against bankruptcy. This means

### Assignment Expectations

- Answer the assignment questions directly.
- Stay focused on the precise assignment questions. Do not go off on

tangents or devote a lot of space to summarizing general background

materials. - For computational problems, make sure to show your work and explain your steps.
- For short answer/short essay questions, make sure to reference your

sources of information with both a bibliography and in-text citations.

See the Student Guide to Writing a High-Quality Academic Paper,

including pages 11-14 on in-text citations. Another resource is the

“Writing Style Guide,” which is found under “My Resources” in the TLC

Portal.