Integrated Case Chapters 6 & 7

Malcolm Co. issued $10,000,000 of corporate bonds with 30-year maturity five years ago. The bonds have a coupon rate of 10.125%, pay interest semiannually, and have a part value of $1,000 per bond. The bonds are currently trading at a price of $879.625 per bond. A 25-year Treasury bond with a 6.825% coupon rate (paid semiannually) and $1,000 par is currently selling for $975.42.

Required:
1. Determine the yield spread between the corporate bond and the Treasury bond (in other words, determine the difference between the securities’ yield to maturity). If you are considering investing in Malcolm Co.’s bonds and you have an 11% required rate of return, would you purchase them, assuming you plan to hold them to maturity? Why or why not?
2. Alternatively, you are considering purchasing Malcolm Co. preferred stock. Assume the preferred stock has a current market price of $42, a par value of $50 and a dividend of 10% of par. Would you be willing to buy the firm’s preferred stock? Why or why not? You have a required rate of return of 12.5% for investments of this type.
3. Now assume that Malcolm Co. has EPS of $1.89; 750,000 common stocks outstanding; and recently paid a dividend of $0.65 per share. Additionally, the firm generated a net income of $1,417,500 and has common stockholder’s equity of $6,000,000 (book value). You believe the firm is in a constant state of growth and your required rate of return for investments of this risk level is 18%. The firm’s common stock is currently trading for $45 per share. Based upon this information, would you be willing to purchase shares of common stock in the firm? Why or why not? Use the discounted dividend model (Hint: the constant growth rate needed for the calculations can be estimated as the product of the retention ratio and the return on equity).
4. Would your decision to purchase