Reference no: EM132943621

Question - Auschamp 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 Auschamp's stock is 1.5. Assume no market friction and taxes.

Required -

(a) The bond of Auschamp Ltd. was issued 25 years ago and has 5 years to maturity. What is the value of the bond assuming 10 percent rate of current interest rate?

(b) Calculate the Auschamp's bond price one year later from today (t=1). What are the factors affecting bond's yield?

(c) If interest rate is expected to increase, what characteristics and types of the bonds and stocks would have a better performance?

(d) 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 (t=1), just after the dividend has been paid in year one?

(e) As an investor, you would like to include Auschamp's securities into your portfolio. However, based on your risk tolerance, you prefer a balance portfolio consisting both Auschamp's bond and stock. You have a 3 years financial plan to grow your current investment amount by compounding it at targeted 13 percent per annum. Assume the yield curve is flat and the risk perceived by investors on Auschamp's stock is unchanged. Show your working how you could achieve your goal.