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ECON635 Inter American University of Puerto Rico Gordon Growth Model HW

ECON635 Inter American University of Puerto Rico Gordon Growth Model HW

ECON635 Inter American University of Puerto Rico Gordon Growth Model HW


Home Work!

To obtain full credit, you need to show ALL your work.

Each question is worth six


Feel free to work in groups, but the answers must be written up


Round your

answers to two decimal places.

1. How much would you pay for a Treasury bill that matures in 182 days and pays $10,000 if you

require a 1.8% discount rate?

2. Consider the two bonds described below:

Bond A

Bond B










Coupon Rate

(Paid semiannually)



Face Value



a. If both bonds had a required return of 8%, what would the bonds’ prices be?


Describe what it means if a bond sells at a discount. Are these two bonds selling at a discount?

Why or why not?

3. If the municipal bond rate is 4.25% and the corporate

bond rate is 6.25%, what margi

nal tax rate

would make you indifferent between buyin

g the two bonds?


Suppose Microsoft, Inc. is trading at $27.29 per share. It pays an annual dividend of $0.32 per

share, which is double its last year’s dividend of $0.16 per share. If this trend is expected to

continue, what is the required return (di

scount rate) on Microsoft? Comment on the value of the

required return. Hint: Use the Gordon Growth Model.


Huskie Motor’s just paid an annual dividend of $1.00 per share. Management has promised

shareholders to increase dividends

by a constant rate of 5%. If the required

return is 12%, what

should be the current price per share based on the Gordon Growth Model? Suppose the current

price in the market is $14.25. Should you buy the stock? Why or why not?

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