7.5, 7.6

Which of the following models directly values all of the firmʹs equity, rather than a single share? I. Dividend-discount model II. Total payout model III. Discounted cashflow model I only II only III only II and III

B II only

Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be $641 million. The firmʹs equity cost of capital is 11%. Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares. If Aaronʹs earnings are expected to grow at a constant 7% per year, what is Aaronʹs share price? $12.48 $24.96 $37.44 $49.92

B) P0 = (0.5 × $641 million) / (0.11 - 0.07) = $8012.5 million; Price per share = $8012.5 million / 321 million = $24.96

Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the end of the year to be $960 million. The firmʹs equity cost of capital is 9%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittendenʹs earnings are expected to grow at a constant 3% per year, what is Chittendenʹs share price? $3.74 $2.24 $7.47 $14.94

C) P0 = (0.3 × $960 million) / (0.09 - 0.03) = $4800 million; Price per share = $4800 million / 643 million = $7.47

Valence Electronics has 213 million shares outstanding. It expects earnings at the end of the year of $800 million. Valence pays out 40% of its earnings in total15% paid out as dividends and 25% used to repurchase shares. If Valenceʹs earnings are expected to grow by 7% per year, these payout rates do not change, and Valenceʹs equity cost of capital is 9%, what is Valenceʹs share price? $11.27 $22.54 $60.10 $75.12

D) P0 = (0.4 × $800 million) / (0.09 - 0.07) = $16,000 million; Price per share = $16,000 million / 213 million = $75.12

Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0 million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to repurchase shares. If Sultanʹs earnings are expected to grow by 5% per year, these payout rates do not change, and Sultanʹs equity cost of capital is 10%, what is Sultanʹs share price? $12.00 $24.00 $36.00 $60.00

D) P0 = (0.6 × $6.0 million) / (0.1 - 0.05) = $72 million; P0 = $72 million / 1.2 million = $60.00

Stocks that do not pay a dividend must have a value of $0.

F

Which of the following is a limitation of the dividend-discount model? It requires accurate dividend forecasts, which is not possible. It requires that the growth rate always be higher than the required rate of return, which is not realistic. It cannot handle negative growth rates. It does not consider past earnings and performance.

It cannot handle negative growth rates.

Forecasting dividends requires forecasting the firmʹs earnings, dividend payout rate, and future share count.

T