A fund manager is required to submit an investment proposal to the Investment Committee on the merits
Question:
A fund manager is required to submit an investment proposal to the Investment Committee on
the merits of investing in ABC Corp. As an investment analyst supporting the team, you have
been asked to assist in analysing the bonds and common stock of the company.
You have found the company to have a target capital structure of 70% equity and 30% debt,
and gathered the following information:
Current price of bonds 97% of par
Bonds par value $1000
Coupon rate 8%
Earnings per share- most recent year $2.00
Expected growth rate of dividends 5.10%
Dividend payout ratio 60%
Required rate of return 12.60%
Current price of common stock $18
(a) The bonds were issued 10 years ago, and mature 15 years from today. Coupon payments
are distributed annually. Analyse the YTM of the bonds (including the verification of
your answer with an appropriate Excel function), and the circumstances where bonds
will be trading at discount, premium or at par.
(b) Calculate the company's share price using the Dividend Discount Model, and determine
whether it is worth investing at current price.
(c) Compose a memo to the fund manager, of not more than 500 words, about your
findings on the bond and common stock of ABC Corp, and provide your opinion on the
relative merits of investing in bond vs common stock.
Financial Management for Public Health and Not for Profit Organizations
ISBN: 978-0132805667
4th edition
Authors: Steven A. Finkler, Thad Calabrese