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BFA728 Finance for Managers Solved

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Q1

Present dividend = D0 = 2.35

Required Rate of return = R = 15%

Growth rate for first 5 years = g1 = 22%

Dividend at end of year 1 = D1 = D0 * (1+g1)

Present Value of dividend D1 = PV (D1) = D1/ (1+ R)

Dividend at end of year 2 = D2 = D0 * (1+g1) ^2

Present Value of dividend D2 = PV (D2) = D2/ (1+ R) ^2

Similarly for t<=5,

Dividend at end of year t = Dt = D0 * (1+g1) ^t

a) Present Value of dividend Dt = PV (Dt) = Dt/ (1+ R) ^t Growth rate after 5 years = g = 6%

b) Price of share at end of year 5 = P5 = (D0 * (1+g1)^5 * (1+g))/ (R-g) Present Value of Price of share at end of year 5 = PV(P5) = P5/(1+R)^5

c) Price of share today = PV(D1) + PV(D2) + PV(D3) + PV(D4) + PV(D5) +PV(D1) + PV (P5) For exact calculation refer to attached excel sheet.

d)    Financial Managers consider the following factors while deciding the dividend policy of a company :

a.    Type of industry: Industries with consistent revenues adopt a stable dividend policy.  Industries with uncertain revenues are conservative in paying out dividends.

b.    Age of company: Newer companies retain their earnings to invest back in the business while order ones hand out earnings as dividends.

c.    Leverage: Companies with greater leverage pay out less dividends due to debt liabilities.

d.    Liquidity: If a company has greater cash reserves and other liquid assets, it can afford to pay greater dividends.

e.    Inflation: Higher inflation forces companies to retain more earnings and pay lesser dividends.(Chand, 2015)

Q2

Face Value = F

Time period = n

Since coupon is paid semi-annually, m=2

No. of time coupon is paid = m*n

Coupon Rate = 9.875%

Rate of interest = R

a) Market Value of Bond = (C/m)/(R/m) * [1- 1/(1+R/m)^mn] + F / ( 1 + R/m)^mn

b) Bond price increases with decrease in interest rate and vice-versa (Exact calculation in attached excel)

c) If a bond that is trading on the market is currently priced higher than its original price (its par value), it is called a premium bond. Conversely, if a bond that is trading on the market is currently priced lower than its original price (its par value), it is called a discount bond. The price of a bond decreases with increase in interest rate and vice-versa. (Russo, 2014)

d) Bond price increases with decrease in interest rate and vice-versa (Exact calculation in attached excel)

Solutions

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