1. Calculating Rates of Return. You?re trying to choose between two different
investments, both of which have up-front costs of $40,000. Investment G returns
$70,000 in six years. Investment H returns $120,000 in 12 years. Which of these
investments has the higher return?

2. Zero Coupon Bonds. Suppose your company needs to raise $15 million and you
want to issue 20-year bonds for this purpose. Assume the required
return on your bond issue will be 8 percent, and you?re evaluating two
issue alternatives: an 8 percent annual coupon bond and a zero coupon
bond. Your company?s tax rate is 35 percent.

How many of the coupon bonds would you need to issue to raise the
$15 million? How many of the zeroes would you need to issue?

3. Stock Valuation. Creed Corp. will pay a dividend of $4 next year.
The company has stated that it will maintain a constant growth rate of
5 percent a year forever. If you want a 15 percent rate of return, how
much will you pay for the stock?

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Request for Question Clarification by livioflores-ga on 11 May 2005 23:26 PDT

Hi!!

Am I right if assume that here is a copy and paste typo and you are
asking only for the answer to the problem #3 in this question?

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Clarification of Question by yourtime4mymoney-ga on 11 May 2005 23:30 PDT

yes, you are correct, this is only for #3.

Hi again!!

The Constant Growth Formula for stock valuation assumes that a company
grows at a constant rate forever, and states that:

P = D1 / (Ks - G)

Where:
P = Price 
D1 = The next dividend
Ks = Rate of Return 
G = Growth Rate 


So for Creed Corp. we have that:

P = $4 / (0.15 - 0.05) =
  = $4 / 0.10 =
  = $40

You must pay for the stock $40 .


For references on stck valuation see:
"Stock Valuation":
http://teachmefinance.com/stockvaluation.html


"Basis for Valuation of Financial Securities":
http://www.ssc.uwo.ca/bacs/courses/310/peters/VALUATION%20OF%20FINANCIAL%20SECURITIES%20FOR%20FINAL%20EXAM.pdf


I hope that this helps you. Please do not hesitate to request for any
clarification needed.

Regards.
livioflores-ga

Regarding to the problem #2 the following page could be useful:
"Introduction to bonds".
See from slide 17, where the Pricing Bonds section starts.
http://www.bus.indiana.edu/anellul/F303_Eight%20Class.ppt