please see attached question
Problem 2: SECURITY VALUATION AND THE FUNDAMENTALS OF BOND AND STOCK PRICES
Suppose you are working on a bond issue for WeWork, a U.S. based firm with a BB credit rating. WeWork plans to issue 10-year par bonds with a face value of $1,000, and has not issued debt before. A competitor with a similar bond rating as WeWork issued 15-year par bonds 5 years ago with face value of $1,000 and an annual coupon rate of 6.5% (paid semi-annually). These bonds are currently trading in the market at a price of $910.88. The 15-year US Treasury bond rate 5 years ago was 2% and the yield on 10year par US Treasury bonds today is 3%. With this information, answer the following two questions.
What is the yield to maturity on the bonds that WeWork’s competitor issued 5 years ago? And what would be the coupon rate at which you expect WeWork could issue the 10-year par bonds today? Clearly describe the inputs to your calculations and motivate your answer.
Explain why the corporate bonds issued by the competitor 5 years ago are trading below par. Also discuss how the risk of these bonds has changed over time. Are investors today more or less concerned about the interest rate risk and the credit risk of the competitor’s bonds than they were 5 years ago? Explain your answer (no calculations are needed).
A mature U.S. telecommunications company expects to pay a dividend per share of $6 next year (paid annually at the end of the year) and expects the dividend to grow at a constant rate in the future. The firm’s equity beta equals 0.65. The risk free rate is 3%, and the expected return on the stock market index is 8%. The firm reinvests 20% of its earnings at an ROE of 12.5%. The current book value per share is $60. With this information, please answer the following two questions.
Determine the required return on the stock based on CAPM and calculate the intrinsic value per share for the telecommunications company. Also explain the difference between the market value and the book value per share. Motivate your answer and show your calculations.
Suppose the firm wants to grow at a higher rate of 7.5% in the future. If the firm keeps its ROE at 12.5%, what would be the impact of this strategy on the dividend in the short run and the value per share? And what would be the impact on the dividends and the value per share if the firm expects to increase its ROE to 15%? Explain your answer (no calculations are needed).
