Chapter 7 FIN5200
Larry also holds 2,000 shares of common stock in a company that only has 20,000 shares outstanding. The company's stock currently is valued at $50.00 per share. The company needs to raise new capital to invest in production. The company is looking to issue 5,000 new shares at a price of $40.00 per share. Larry worries about the value of his investment. Larry's current investment in the company is ___________ . If the company issues new shares and Larry makes no additional purchase, Larry's investment will be worth______________.
$100,000; $96,000 Because New Market Value = (Existing Price x Existing Shares) + (New Price x New Shares) = ($50.00 x 20,000 shares) + ($40.00 x 5,000 shares) = $1,200,000
SCI just paid a dividend (D₀) of $1.44 per share, and its annual dividend is expected to grow at a constant rate (g) of 3.00% per year. If the required return (rss) on SCI's stock is 7.50%, then the intrinsic value of SCI's shares is ______ per share.
$32.96 because you need to calculate the expected dividend in year 1 (D₁) =$1.44 x (1 + 0.0300) =$1.4832 per share then, the value of a constant growth stock: =$1.4832/(0.07500 - 0.0300) =$32.96 per share
Investment Value =
(Existing Price x Existing Shares) + (New Price x New Shares)
Suppose you have the information given in the following table for Company X. Year 1 Year 2 EBITDA $21,360 $24,750 Total value of equity $243,000 $225,000 Total firm value $364,500 $405,000 What is value of the entity multiple of Company X in Year 1?
17.06 because Entity Multiple=Total Value of the Firm / EBITDA=$364,500 / $21,360 =17.06
Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $1.85 at the end of the year. Its dividend is expected to grow at a constant rate of 6.00% per year. If Walter's stock currently trades for $13.00 per share, what is the expected rate of return?
20.23% because dividend rate of return = expected dividend yield + capital gains yield or Expected rate of return = rs=D1/P0+gL where: Dt = dividend the stockholder expects to receive at the end of year t P0=actual market price of the stock gL=long-term growth rate rs = ($1.85/$13.00)+0.0600
Use the constant growth model to calculate the appropriate values to complete the following statements about Super Carpeting Inc.: (Note: Do not round your intermediate calculations.) •If SCI's stock is in equilibrium, the current expected dividend yield on the stock will be _________ per share. •SCI's expected stock price one year from today will be ______ per share. •If SCI's stock is in equilibrium, the current expected capital gains yield on SCI's stock will be _______ per share.
4.50%; $33.95; 3.00% because DYSCIDYSCI=$1.4832/$32.96 =0.04500 =4.50% per share and D₂=D₀ x (1 + g)² =D₁ x (1 + g) =$1.4832 x (1 + 0.0300) =$1.5277 per share then =$32.96 x (1 + 0.0300) =$33.95 per share and CGYSCICGYSCI=($33.94889 - $32.96)/$32.96=0.0300, or 3.00% per share
Robert Gillman, an equity research analyst at Gillman Advisors, believes in efficient markets. He has been following the mining industry for the past 10 years and needs to determine the constant growth rate that he should use while valuing Pan Asia Mining Company. Robert has the following information available: •Pan Asia Mining Company's stock (Ticker: PAMC) is trading at $22.50.•The company's stock is expected to pay a year-end dividend of $1.08 that is expected to grow at a certain rate.•The stock's expected rate of return is 10.80%. Based on the information just given, what will be Robert's forecast of PAMC's growth rate?
6.00% because r̂s = Expected Dividend Yield(D1/P0) + Expected Growth Rate(gL) gL= r̂s - (D1/P0) = 0.1080 - (1.08/22.50) =6%
Required Return on Stock X
= Risk-Free Return + (Market Risk Premium x Stock X's Beta)
Intrinsic Stock Price
= intrinsic value of equity / number of shares
The CEO of EchoStar Communications, Charlie Ergen, owned around 50% of the company's stock, but his multiple votes per share gave him around 90% of the vote. Based on this example, which of the following statements is true?
Classified shares have super voting rights, which give more control to a certain class of investors.
Calculate the expected annual dividend for next year (D1D1) and for the year after (D2D2) to find the expected dividend values
D1 = D0×(1+gs) where Dt=dividend the stockholder expects to receive at the end of year t g=growth rate in dividends
Portman Industries just paid a dividend of $2.40 per share. The company expects the coming year to be very profitable, and its dividend is expected to grow by 20.00% over the next year. After the next year, though, Portman's dividend is expected to grow at a constant rate of 4.00% per year. What is the expected dividend yield for Portman's stock today?
Dividends one year from now (D1)$2.8800 Horizon value (Pˆ1) $34.04 Intrinsic value of Portman's stock $32.73 Required Return on Stock X = Risk-Free Return + (Market Risk Premium x Stock X's Beta) = 5.00%+(6.00%) × 1.30 =12.80% Dividends 1 year from now: $2.88 Calculate the expected annual dividend for next year (D1) and for the year after (D2) to find the expected dividend values: D1 = D0×(1+gs) = $2.40×(1 + 20.00%) =$2.88 per share D2 = D1×(1+gn) = $2.8800 ×(1 + 4.00%) = $2.9952 per share Horizon Value=$34.04 =$2.99/(12.80%-4%) =$34.04 per share Intrinsic Value=32.73 =(D1/(1+rs)^1) + (P1/(1+rs)^1) =($2.88/(1+0.1280)^1) + ($34.04/(1+0.1280)^1) =$32.73
Edinburgh Exports pays an annual dividend rate of 10.40% on its preferred stock that currently returns 13.94% and has a par value of $100.00 per share. What is the value of Edinburgh's preferred stock? Suppose that there is high unemployment, which causes interest rates to fall, which in turn pulls the preferred stock's yield to 8.36%. The value of the preferred stock will
Dps=Dividend rate * par value 10.40*100 =10.40 per share then Vps=Dps/rps =10.40/13.94% =$74.61 per share Increase because $10.40/8.36%=$124.40 per share
Future value of a dividend
Dt=D₀ (1 + g)^t Example: D10=$1.00 x (1 + 0.0350)1010 = $1.4106 Note: FV uses the growth rate
r̂s =
Expected Rate of Return = Expected Dividend Yield + Expected Capital Gains Yield
Calculate the horizon value of ___________ stock
Horizon value = (DN+1)/(rg-gn)
Which of the following statements is true? -Increasing dividends will always decrease the stock price, because the firm is depleting internal funding resources. -Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth. -Increasing dividends will always increase the stock price.
Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth.
Which of the following statements accurately describes the relationship between earnings and dividends when all other factors are held constant? -Paying a higher percentage of earnings as dividends will result in a higher growth rate. -Dividend growth and earnings growth are unrelated. -Long-run earnings growth occurs primarily because firms retain earnings and reinvest them in the business.
Long-run earnings growth occurs primarily because firms retain earnings and reinvest them in the business.
New Share Value =
New Market Value/Total Outstanding Shares
The present value of a dividend
PVt= Dt/(1+rs)^t PV for Year 10=FV of year 10/(1+required return)^10 Example: PVt = $1.41/(1+0.1040)^10 =$0.52 or, in Excel: = FV(rate, nper, pmt, [pv], [type]) = PV(0.1040, 10, 0, -$1.4106, 0) =$0.52 Note: PV uses the required return rate
Which of the following statements will always hold true? -The constant growth valuation formula is not appropriate to use unless the company's growth rate is expected to remain constant in the future. -The constant growth valuation formula is not appropriate to use for zero growth stocks. -It will never be appropriate for a rapidly growing startup company that pays no dividends at present—but is expected to pay dividends at some point in the future—to use the constant growth valuation formula.
The constant growth valuation formula is not appropriate to use unless the company's growth rate is expected to remain constant in the future.
The following graph shows the value of a stock's dividends over time. The stock's current dividend is $1.00 per share, and dividends are expected to grow at a constant rate of 3.50% per year. The intrinsic value of a stock should equal the sum of the present value (PV) of all of the dividends that a stock is supposed to pay in the future, but many people find it difficult to imagine adding up an infinite number of dividends. Calculate the present value (PV) of the dividend paid today (D₀) and the discounted value of the dividends expected to be paid 10 and 20 years from now (D1010 and D2020). Assume that the stock's required return (rss) is 10.40%.
Time Period Dividend's Expected Future Value Expected Dividend's Present Value Now $1.0000 End of Year 10 $1.4106 $0.5245 End of Year 20 $1.9898 $0.2751 End of Year 50 $5.5849 $0.0397 because Future Value= Dt = D₀ (1 + g)^t D1010=$1.00 x (1 + 0.0350)1010 = $1.4106D2020 =$1.00 x (1 + 0.0350)2020 = $1.9898D5050 =$1.00 x (1 + 0.0350)5050 = $5.5849 and PVt=Dt/(1+rs)^t Using these expected future cash flows, the present values are calculated by discounting the expected dividends using the expected return (rss) of 10.40%
True or False: In some cases, individuals who start a business have special voting rights that help them exercise more control over the firm. They own a special class of stock called founders' shares.
True
Which of the following statements is true about the constant growth model?
When using a constant growth model to analyze a stock, if an increase in the required rate of return occurs while the growth rate remains the same, this will lead to a decreased value of the stock.
Suppose you work for a mutual fund firm. Your team is thinking of investing in EchoStar's stock. Your task is to create a report on the stock's performance and investment potential. In this scenario, you are working as a ________
buy-side analyst.
A ___________ is a provision that gives shareholders the right to buy new shares in any new share issuance in proportion to their existing stake in the company.
preemptive right
A _________ is a document that gives a person or group the authority to act on behalf of another—in this case, it transfers shareholder voting rights to management.
proxy
