On January 1, 2013, you are planning to buy the bonds and stocks issued by Mega Corporation. The bonds have a face value of $1000 and maturity of 5 years with a coupon rate of 8% and coupon payments are made semi annually. Mega Corporation is expected to pay a dividend of $1.50 on December 31, 2014 and this dividend is expected to grow at 7% every year after 2014. The risk-free rate is 2%, market risk premium is 7%, beta of the bond is 0.8 and beta of the stock is 1.2.
a) Apply the principle of time value of money to calculate the price at which bond can be bought.
b)Calculate the price at which a share of the stock can be bought.