Meta Computer Ltd. has an outstanding issue of bond with a par value of $1,000, paying 8 percent coupon rate semi-annually. And, the company just paid a dividend of $2.70 per share. The dividends are expected to grow at 5.0 percent for next 2 years. i.e. year 1 and 2, and after year 2, dividends are estimated to grow at 4 percent thereafter indefinitely. Based on market information, government bond’s yield for 10-year maturity is 5 percent, market expected return is 15 percent, and beta of Meta’s stock is 1.5. Assume no market friction and taxes. Required: (a) The bond of Meta Computer Ltd. was issued 20 years ago and has 10 years to maturity. What is the value of the bond assuming 10 percent rate of current interest rate (yield- to-maturity)? (b) If interest rate is expected to decrease, what characteristics of bonds would have better performance?
(c) Assume that the forecasted dividends and the required rate of return are the same one year from now, as those forecasted today. What is the expected intrinsic value of the stock one year from now, just after the dividend has been paid in year one?
(d) If interest rate is expected to decrease, what characteristics of stock based on CAPM would have better performance? Do you prefer to invest in Meta’s stock or bond if interest rate is lower and why?
