1. The price of the normal bond is $1/R; the price of the growth bond is $X/(R - g). These prices are equal if X = (R - g)/R = (0.05 - 0.02)/0.05 = 0.60
Alternatively, we use R = D/P + g to reason that
growth: 0.05 = X/P + 0.02 implies X/P = 0.03 implies X = 0.03($20) = $0.60
2. Its earnings 5 years from now will be $0.74(1.59^5) = $7.52. The first dividend will be 0.7($7.52) = $5.26. Using P = D1/(R - g), the price four years from now (a year before the first dividend) will be P4 = $5.26/(0.055 - 0.045) = $526. The current price is P4/(1 .045)^4 = $441.42.
3. The duration of Cisco Systems stock is larger than 5 years, since there is no cash flow for 5 years.
4. This assumes no risk premium. Yes, it makes a big difference. If we put on a 1% risk premium, the denominator of P4 doubles, reducing the value by 50%.
5. Long-term rates since long-term bonds are closer substitutes for stocks. Yes, it matters a lot. Replacing 0.055 with 0.060 increases the denominator of P4 by 50%, reducing the value by a third.
6. No effect, since the present value of nominal cash flows discounted by a nominal required return is equal to the present value of real cash flows discounted by a real required return.
7. Infinite, since g > r.
8. Using g = (1- d)*r, with g = 0.59 and d = 0, we have ROE = 0.59.
9. This would create a tax shield.
10. This depends critically on whether the profit rate on these reinvested earnings is larger or smaller than the shareholders' required rate of return.