MGT201 Assignment # 2 idea solution

“Financial Management (MGT201)”
Assignment No. 02

Answer A:
Value of company’s stock = Dividend (1+ dividend growth rate) / required rate of return-dividend growth rate.

Value of company’s stock = 4.2 (1+0.07) / 0.13-0.07
= 4.2 (1.07) / 0.06
= 4.494 / 0.06
= 74.90

Answer B:
Gordon-SML equation method
Required rate of return (Gordon-SML equation method) = risk free rate + beta (market rate of return - risk free rate)
Required rate of return (Gordon-SML equation method) = 10 + 2(15-10)
= 10 + 2(5)
= 10 + 10
= 20%

Ideal value = Dividend (1+ dividend growth rate) / required rate of return-dividend growth rate
= 4.6 (1+0.085) / 0.2 - 0.085
= 4.6 (1.085) / 0.115
= 4.991 / 0.115
= 43.4

Current stock value is Rs 30; it must be Rs. 43.4 which means that the stock is undervalued.

Answer C:
Intrinsic value of Company C’s bond

= (140/5) / (1+0.16 / 4)20 + 1000 / (1.165)
= 492.09

Answer D:
As per the analysis, the investor can buy Company’s stock, as the current value of stock is Rs74.9 but its selling price is Rs. 60.5. You can expect to earn profit in the future.

The investor should buy Company B stock, as the current value of the stock is Rs 43.4 but it is being sold in the market for Rs30. You can expect appreciation in the value of the stock in the future and can gain.

The investor should not buy Company C bond, as the fair value of the bond today is Rs492.0866 but is being sold for Rs 850 in the market. The bond looks expensive. You can earn more by investing your money in bank deposits rather than investing in bond.

Answer E:
Assuming that he is investing Rs250000 in Company A and Rs250000 in Company B

Return on Company A stock = 14% * 250000 = Rs35000
Return on company b stock = 19% * 250000 = Rs47500
Return on portfolio = 35000+47500/500000 = 16.5%