1) ABC Investment Advisors is considering investing in bonds and stock issued by Major Works Incorporated. As part of the decision process, ABC is estimating Major's bond and stock values and expected returns. Given below is the information determined by their research:

A. The current market price of Major's outstanding corporate bonds is 107% of their $1,000 par value. The bonds have an annual coupon rate of 6.4% and make coupon payments semiannually. The bonds mature in 15 years.

B. The current price of the firm's preferred stock is $86.00 per share. The stock has a $100 par value and a 4.4% annual dividend rate (paid annually).

C. The current price of the firm's common stock is $765.00 per share. Its next (upcoming) semiannual dividend will be D1 = $3.80 per share. Dividends are paid semiannually and are expected to grow at an annual rate of 4% into the foreseeable future. NOTE that $3.80 is the amount of the semiannual dividend. It does not need to be divided by two.

2. ABC Investment Advisors is basing its analysis on a required rate of return equal to 5% per year.) Refer to the information concerning Major Works Incorporated in problem #1. In discussions with the company's CEO, you learn that a decision has been made to eliminate future dividends on the company's common stock. This means that, since your estimate of the expected return of common equity was based on the Discounted Cash Flow Method and a forecast of future dividend payments, that estimate needs to be updated.

It will be necessary to recalculate the expected return on common stock using the Capital Asset Pricing Model (CAPM). Research shows you the following: