Chapter 9 PRE, HW, and Clicker Questions

D - $15.45 D0 $1.50 rS 14.1% g 4.0% D1 = D0(1 + g) = $1.56 P0 = D1/(rS - g) $15.45

A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 14.1%, and the constant growth rate is g = 4.0%. What is the current stock price? a. $19.15 b. $18.84 c. $12.82 d. $15.45 e. $12.97

B - $32.61 D1 $0.75 rS 10.5% g 8.2% P0 = D1/(rS - g) $32.61

A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 8.2%. What is the stock's current price? a. $38.80 b. $32.61 c. $27.39 d. $29.02 e. $27.07

E - $1.22 Stock price $29.00 Required return 11.50% Growth rate 7.00% P0 = D1/(rS - g), so D1 = P0(rS - g) = $1.3050 Last dividend = D0 = D1/(1 + g) $1.22

Goode Inc.'s stock has a required rate of return of 11.50%, and it sells for $29.00 per share. Goode's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend, D0? a. $0.95 b. $1.37 c. $1.38 d. $1.06 e. $1.22

P0 = $27; D0 = $2; g = 9%; P hat 1 = ?; rs = ? A) P hat 1 = P0 (1 + g) = 27(1.09) = $29.43 B) Rs = D1 / P0 + g = (2 x 1.09) / 27 + 0.09 = 17.07%

Holtzman Clothiers's stock currently sells for $27 a share. It just paid a dividend of $2 a share (i.e., D0 = $2). The dividend is expected to grow at a constant rate of 9% a year. A) What stock price is expected 1 year from now? Round your answer to two decimal places. B) What is the required rate of return? Round your answer to two decimal places. Do not round your intermediate calculations.

E - $28.77 Stock price $24.50 Growth rate 5.50% Years in the future 3 P3 = P0(1 + g)3 = $28.77

Reddick Enterprises' stock currently sells for $24.50 per share. The dividend is projected to increase at a constant rate of 5.50% per year. The required rate of return on the stock, rS, is 9.00%. What is the stock's expected price 3 years from today? a. $31.65 b. $24.45 c. $33.66 d. $26.76 e. $28.77

D Horizon value at time 3, P3 = D4/(rs-g) D4 = D3*(1+0.07) = D0*(1+0.29)^3*(1+0.07) = 6.317; where D0=2.75. Remember last dividend means D0. So P3 = 6.137/(0.12-0.07) = 126.33

Tapley Tank Company's last dividend was $2.75. The dividend growth rate is expected to be constant at 29% for 3 years, after which dividends are expected to grow at a rate of 7% forever. Tapley's required return (rs) is 12%. What will Tapley's stock price be in 3 yrs (horizon value)? a. 80.94 b. 97.93 c. 118.07 d. 126.33

D1 = $3.9; g = 6%; rs = 19%; Current value per share = ? 3.9 / (0.19 - 0.06) = $30.00

Tresnan Brothers is expected to pay a $3.9 per share dividend at the end of the year (i.e., D1 = $3.9). The dividend is expected to grow at a constant rate of 6% a year. The required rate of return on the stock, rs, is 19%. What is the stock's current value per share? Round your answer to two decimal places.

E - Assuming that the book value of debt is close to its market value, the total market value of the company is: Total Market Value = Total value of operation + Value of nonoperating assets TMV = $1,150 Value of Equity = Total MV - (Long + Short-term debt +preferred stock) Value of Equity = $1,150 - (120 + 300 + 50) = 680 Stock price per share = Value of equity / stock outstanding Stock price per share = $680/ 30 million = $22.67

Based on the corporate valuation model, Gray Entertainment's total corporate value is $1,150 million. The company's balance sheet shows $120 million of notes payable, $300 million of long-term debt, $50 million of preferred stock, $180 million of retained earnings, and $800 million of total common equity. If the company has 30 million shares of stock outstanding, what is the best estimate of its price per share? a. $26.07 b. $17.68 c. $22.44 d. $18.81 e. $22.67

(1) Ownership (2) Dividend (3) Are not

Common stock represents the *(1) *position in a firm and is valued as the present value of its expected future *(2) *stream. Common stock dividends *(3) * specified by contract—they depend on the firm's earnings. Two models are used to estimate a stock's intrinsic value: the discounted dividend model and the corporate valuation model.

A - 5.95% Expected dividend (D1) $1.25 Stock price $27.50 Required return 10.5% Dividend yield 4.55% Growth rate = rS - D1/P0 = 5.95%

Gray Manufacturing is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $27.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate? a. 5.95% b. 6.07% c. 5.54% d. 6.01% e. 6.91%

C - $1,289 FCF3 $55.00 g 5.5% WACC 10.0% FCF4 = FCF3(1 + g) = $58.0250 HV3 = FCF4/(WACC - g) = $1,289

Misra Inc. forecasts a free cash flow of $55 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5.5% thereafter. If the weighted average cost of capital (WACC) is 10.0% and the cost of equity is 15.0%, what is the horizon, or continuing, value in millions at t = 3? a. $1,212 b. $1,186 c. $1,289 d. $1,083 e. $1,148

C - r = 3% + (5% x 1.5) = 10.5%

The Lashgari Company's beta is 1.5; the market risk premium is 5%, and the risk-free rate is 3%. What is the company's required rate of return? a. 3.0% b. 7.5% c. 10.5% d. 15%

B

Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT? a. The two stocks must have the same dividend yield. b. If one stock has a higher dividend yield, it must also have a lower dividend growth rate. c. The two stocks must have the same dividend growth rate. d. If one stock has a higher dividend yield, it must also have a higher dividend growth rate. e. The two stocks must have the same dividend per share.

D0 = $3.75; g1-3 = 12%; gn = 3%; D1 through D5 = ? D1 = D0(1 + g1) = $3.75(1.12) = $4.2000 ≈ $4.20 D2 = D0(1 + g1)(1 + g2) = $3.75(1.12)2 = $4.7040 ≈ $4.70 D3 = D0(1 + g1)(1 + g2)(1 + g3) = $3.75(1.12)3 = $5.2685 ≈ $5.27 D4 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn) = $3.75(1.12)3(1.03) = $5.4265 ≈ $5.43 D5 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn)2 = $3.75(1.12)3(1.03)2 = $5.5893 ≈ $5.59

Weston Corporation just paid a dividend of $3.75 a share (i.e., D0 = $3.75). The dividend is expected to grow 12% a year for the next 3 years and then at 3% a year thereafter. What is the expected dividend per share for each of the next 5 years? Round your answers to two decimal places.

C

Which of the following statements is CORRECT? A. A two-stock portfolio will always have a lower beta than a one-stock portfolio. B. A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. C. A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market. D. A stock with a higher standard deviation must also have a higher beta. E. If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio

A

You are given the following returns on the Market and on Stock A. Calculate Stock A's beta coefficient. (Market as X variable, Stock as Y variable) Year ---------- Market ---------- Stock A 2001 ---------- -20% ---------- -35% 2002 ---------- -5 ---------- -15 2003 ---------- 40 ---------- 45 2004 ---------- 25 ---------- 40 2005 ---------- 10 ---------- 10 A. 1.43 B. 1.23 C. 1.03 D. 1.33 E. 1.13

A - $46.11 FCF1 $24.50 Constant growth rate 7.0% WACC 10.0% Debt & preferred stock $125 Shares outstanding 15 Total firm value = FCF1/(WACC - g) = $816.67 Less: Value of debt & preferred -$125.00 Value of equity $691.67 Number of shares 15 Value per share = Equity value/Shares = $46.11

You must estimate the intrinsic value of Noe Technologies' stock. The end-of-year free cash flow (FCF1) is expected to be $24.50 million, and it is expected to grow at a constant rate of 7.0% a year thereafter. The company's WACC is 10.0%, it has $125.0 million of long-term debt plus preferred stock outstanding, and there are 15.0 million shares of common stock outstanding. What is the firm's estimated intrinsic value per share of common stock? a. $46.11 b. $47.96 c. $34.58 d. $38.27 e. $40.12

E - 6.96% Pref. quarterly dividend $1.00 Annual dividend = Qtrly dividend × 4 = $4.00 Preferred stock price $57.50 Nom. required return = Annual dividend/Price = 6.96%

Carter's preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $57.50, what is its nominal (not effective) annual rate of return? a. 6.75% b. 5.84% c. 8.56% d. 7.03% e. 6.96%

D

If markets are in equilibrium, which of the following conditions will exist? a. Each stock's expected return should equal its realized return as seen by the marginal investor. b. All stocks should have the same realized return during the coming year. c. The expected and required returns on stocks and bonds should be equal. d. Each stock's expected return should equal its required return as seen by the marginal investor. e. All stocks should have the same expected return as seen by the marginal investor.

A First find out horizon value, P3 = FCF4/(rs-g) = FCF3*1.06/(rs-g) = 20*1.06/(0.10-0.06) =530 Register CFs as CF0 =0; C01 = -10, F01 = 1; C02 = 10, F01 = 1; C03 = 20 + 530 =550, F01 = 1; With discount rate I = rs =10, NPV = 412.40

If your company plans to take over the company with cash flows of -10, 10, 20 for next three years and with a long-run growth rate of 6%, how much your company should pay for the target company assuming WACC = 10%? R = 10%, g = 6% after year 3 a. 412.40 b. 414.39 c. 398.20 d. 416.94

D

Market equilibrium for a stock would imply which of the following? a. Historical return in last year = expected return in the coming year b. Historical return in the last year = required return in the coming year c. Historical return = required return = expected return d. Required return = expected return

(1) Corporate valuation (2) Free-cash flows

The *(1) *model is an alternative model used to value a firm, especially one that does not pay dividends or is privately held. This model calculates the firm's *(2) *, and then finds their present values at the firm's weighted average cost of capital to determine a firm's value.

D

Which of the following statements is correct? a. The only difference between the discounted dividend and corporate valuation models is the expected cash flow stream. Expected future dividends are the cash flow stream in the discounted dividend model and expected free cash flows are the cash flow stream in the corporate valuation model. Both models use the same discount rate to calculate the present value of the cash flow stream. b. The discounted dividend model is especially suited for valuing companies that are privately held. c. The only difference between the discounted dividend and corporate valuation models is the discount rate used to calculate the present value of the cash flow stream. The discount rate used in the discounted dividend model is the firm's required rate of return on equity, while the discount rate used in the corporate valuation model is the firm's weighted average cost of capital. Both models use the same expected cash flow stream in the discounting process. d. There are actually two differences between the discounted dividend and corporate valuation models: the expected cash flow stream and the discount rate used in the models are different. The discounted dividend model calculates the firm's stock price as the present value of the expected future dividends at the firm's required rate of return on equity, while the corporate valuation model calculates the firm's stock price as the present value of the expected free cash flows at the firm's weighted average cost of equity.

E

Which one below would yield most diversification for a portfolio? A. Correlation = 1 B. Correlation = 0.8 C. Correlation = 0.5 D. Correlation = 0 E. Correlation = -0.1

A - Growth rate 5.25% Years in the future 5 Stock price $35.25 P5 = P0(1 + g)^5 = $45.53

Whited Inc.'s stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 5.25% per year. The required rate of return on the stock, rs, is 11.50%. What is the stock's expected price 5 years from now? a. $45.53 b. $39.15 c. $52.81 d. $47.80 e. $40.06

C FCF1 = 26 g = 0.085 WACC=rs = 0.11 Value of Firm = FCF1/(rs -g) = 26/(0.11-0.085) = 1,040 Stock value = (Firm's value - Debt value )/# of shares = (1040 - 200)/30 = 28

You must estimate the intrinsic value of Gallovits Technologies' stock. Gallovits's end-of-year free cash flow (FCF) is expected to be $26 million, and it is expected to grow at a constant rate of 8.5% a year thereafter. The company's WACC (discount rate) is 11%. Gallovits has $200 million of long-term debt plus preferred stock, and there are 30 million shares of common stock outstanding. What is Gallovits's estimated intrinsic value per share of common stock? a. 26 b. 27 c. 28 d. 30

Current price = P hat 0 = = D0 (1 + g)/(rs - g) = $1.60(1.03)/(0.09 - 0.03) = $1.648/0.06 = $27.47 per share

Hubbard Industries just paid a common dividend, D0, of $1.60. It expects to grow at a constant rate of 3% per year. If investors require a 9% return on equity, what is the current price of Hubbard's common stock? Round your answer to the nearest cent. Do not round intermediate calculations. $ _____ per share

A - ri = rRF + (rM - rRF)bi

Niendorf Corporation's stock has a required return of 12.00%, the risk-free rate is 5.50%, and the market risk premium is 5.00%. Now suppose there is a shift in investor risk aversion, and the market risk premium increases by 2.00%. What is Niendorf's new required return? (Step 1: find beta; Step 2: use beta to calculate ri) A. 14.6% B. 14.0% C. 8.1% D. 7.5%

C Current stock price is discounted sum of D1, D2, D3+P3 D1 = D0*1.29 = 3.5475 D2 = D1*1.29 = 4.5763 D3 = D2*1.29 = 5.9034 P3 = 126.33 from previous question Register CFs as CF0 =0; C01 = 3.5475, F01 = 1; C02 = 4.5763, F01 = 1; C03 = 5.9034 + 126.33 =132.2334, F01 = 1; With discount rate I = rs =12, NPV = 100.94

Tapley Tank Company's last dividend was $2.75. The dividend growth rate is expected to be constant at 29% for 3 years, after which dividends are expected to grow at a rate of 7% forever. Tapley's required return (rs) is 12%. What is Tapley's current stock price? a. 80.94 b. 90.94 c. 100.94 d. 110.94

A - Pc = bi / rs - g = 0.75 / (0.105 - 0.05) = 13.64

The Lashgari Company is expected to pay a dividend of $0.75 per share at the end of the year, and that dividend is expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.5; the market risk premium is 5%, and the risk-free rate is 3%. What is the company's current stock price? (Hint: find required rate of return first and then stock price.) a. 13.64 b. 11.33 c. 10.50 d. 7.50

C is correct answer A: expected return will be 10.5%, equal to required return, if the market is in equilibrium. B: required rate of return rs= rRF + b * MRP = 0.03 + 1.5*0.05 = 0.105 C: for constant dividend growth, the price grows at constant rate of dividend growth "g" = 5% as given. D: dividend yield + capital gains yield = 10.5%, while capital gains yield = g = 5% for constant growth model. So dividend yield = 5.5%. E: stock price actually grows at constant rate 5%. Stock price is NOT constant.

The Lashgari Company is expected to pay a dividend of $0.75 per share at the end of the year, and that dividend is expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.5; the market risk premium is 5%, and the risk-free rate is 3%. Which of the statement is correct? a. The expected return on the stock is 5% a year. b. The stock's required return must be equal to 5%. c. The stock's price one year from now is expected to be 5% higher. d. The stock's dividend yield is 5%. e. The price of the stock is expected to remain constant in the future due non-constant dividend growth.

Discounted dividend

The __________ model values a common stock as the present value of its expected future cash flows at the firm's required rate of return on equity. Variations of this model are used to value constant growth stocks, zero growth stocks, and non-constant growth stocks.

D

The preemptive right is important to shareholders because it a. will result in higher dividends per share. b. protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate. c. is included in every corporate charter. d. protects the current shareholders against a dilution of their ownership interests. e. allows managers to buy additional shares below the current market price.

B

What is the expected return for MP? Economy ---------- Probability ---------- MP Recession ---------- 0.1 ---------- -17.0% Below avg --------- 0.2 ---------- -3.0% Average ---------- 0.4 ---------- 10.0% Above avg ---------- 0.2 ----------- 25.0% Boom ----------- 0.1 ---------- 38.0% A. 12.4% B. 10.5% C. 9.8% D. 5.5% E. 1.0%

D

What is the standard deviation for MP, given expected return of 10.5% Economy ---------- Probability ---------- MP Recession ---------- 0.1 ---------- -17.0% Below avg --------- 0.2 ---------- -3.0% Average ---------- 0.4 ---------- 10.0% Above avg ---------- 0.2 ----------- 25.0% Boom ----------- 0.1 ---------- 38.0% A. 20% B. 0% C. 13.2% D. 15.2% E. 18.8%

Calculate FCF6: FCF6 = $55.6 (1.05) = $58.38 million Calculate the firm's continuing value at Year 5: CV5 = FCF6/(WACC - gFCF) CV5 = $58.38/(0.12 - 0.05) = $834.00 million Calculate the firm's value today: Using your financial calculator, enter the following data: CF0 = 0, CF1 = -22.54, CF2 = 38.1, CF3 = 44, CF4 = 51.1, CF5 = 55.6 + 834.00 = 889.60, and I/YR = WACC = 12. Then, solve for NPV = Firm value = $578.82 million. Calculate the market value of the firm's equity: MVE = $578.82 - $24 = $554.82 million Calculate the firm's current price per share: P0 = $554,824,322.29/21,000,000 = $26.42 False statement

We present 2 examples of the corporate valuation model. In the first problem, we assume that the firm is a mature company so its free cash flows grow at a constant rate. In the second problem, we assume that the firm has a period of nonconstant growth. Quantitative Problem 2: Hadley Inc. forecasts the year-end free cash flows (in millions) shown below. Year 1 2 3 4 5 FCF -$22.54 $38.1 $44 $51.1 $55.6 The weighted average cost of capital is 12%, and the FCFs are expected to continue growing at a 5% rate after Year 5. The firm has $24 million of market-value debt, but it has no preferred stock or any other outstanding claims. There are 21 million shares outstanding. What is the value of the stock price today (Year 0)? Round your answer to the nearest cent. Do not round intermediate calculations. $_____ per share According to the valuation models developed in this chapter, the value that an investor assigns to a share of stock is dependent on the length of time the investor plans to hold the stock. The statement above is_____. Conclusions: Analysts use both the discounted dividend model and the corporate valuation model when valuing mature, dividend-paying firms; and they generally use the corporate model when valuing divisions and firms that do not pay dividends. In principle, we should find the same intrinsic value using either model, but differences are often observed. Even if a company is paying steady dividends, much can be learned from the corporate model; so analysts today use it for all types of valuations. The process of projecting future financial statements can reveal a great deal about a company's operations and financing needs. Also, such an analysis can provide insights into actions that might be taken to increase the company's value; and for this reason, it is integral to the planning and forecasting process.

B - Note that P0 = $2/(0.15 + 0.05) = $10. That price is expected to decline by 5% each year, so P1 must be $10(0.95) = $9.50. Therefore, "The company's expected stock price at the beginning of next year is $9.50" is correct, while all the others are false.

A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT? a. The constant growth model cannot be used because the growth rate is negative. b. The company's expected stock price at the beginning of next year is $9.50. c. The company's expected capital gains yield is 5%. d. The company's current stock price is $20. e. The company's dividend yield 5 years from now is expected to be 10%.

D

Consider the following information for three stocks, A, B, and C. The returns on the stocks are positively but not perfectly correlated with one another, i.e., the correlation coefficients are all between 0 and 1. Stock ----- Expected Return ----- Standard Deviation ----- Beta Stock A: ---- 10% ----- 20% ----- 1.0 Stock B: ---- 10 ---- 20 ---- 1.0 Stock C: ---- 12 ---- 20 ---- 1.4 Portfolio AB has half of its funds invested in Stock A and half invested in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which statement is CORRECT? A. Portfolio ABC has a standard deviation of 20%. B. Portfolio AB's coefficient of variation is greater than 2.0. C. Portfolio AB's required return > the required return on Stock A. D. Portfolio ABC's expected return is 10.67%. E. Portfolio AB has a standard deviation of 20%

A - $45.14 Required return 11.0% Short-run growth rate 27.5% Long-run growth rate 6.0% Last dividend (D0) $1.25 Year 0 1 2 3 4 Dividend $1.2500 $1.5938 $2.0320 $2.5908 $2.7463 Horizon value = P3 = D4/(rS - g4) = 54.9258 Total CFs $1.5938 $2.0320 $57.5166 PV of CFs $1.4358 $1.6492 $42.0557 Price = Sum of PVs = $45.14

Huang Company's last dividend was $1.25. The dividend growth rate is expected to be constant at 27.5% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If the firm's required return (rs) is 11%, what is its current stock price? a. $45.14 b. $36.11 c. $40.63 d. $41.08 e. $52.36

a. Horizon value = (50 x 1.07) / (0.16 - 0.07) = $594.44 million b. 0 1 2 3 4 WACC = 16% gn = 7% -13 32 50 53.5 $-11.2069 x 1/1.16 23.7812 x 1/(1.16)2 Vop3 = 594.44 412.8683 x 1/(1.16)3 644.44 $425.4426 Using a financial calculator, enter the following inputs: CF0 = 0; CF1 = -13; CF2 = 32; CF3 = 644.44; I/YR = 16; and then solve for NPV = $425.44 million. c. Total valuet=0 = $425.44 million Value of common equity = $425.44 - $37 = $388.44 million Price per share = 388.44/10 = $38.84

Dantzler Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Dantzler's WACC is 16%. Year 0 1 2 3 FCF ($ millions) - $13 $32 $50 a. What is Dantzler's horizon, or continuing, value? (Hint: Find the value of all free cash flows beyond Year 3 discounted back to Year 3.) Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $13,550,000 should be entered as 13.55. b. What is the firm's value today? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $13,550,000 should be entered as 13.55. Do not round your intermediate calculations. c. Suppose Dantzler has $37 million of debt and 10 million shares of stock outstanding. What is your estimate of the current price per share? Round your answer to two decimal places. Write out your answer completely. For example, 0.00025 million should be entered as 250.

a. Horizon value = (41 x 1.07) / (0.14 - 0.07) = 43.87/0.07 = $626.71 million b. See picture on phone - Using a financial calculator, enter the following inputs: CF0 = 0; CF1 = -22; CF2 = 19; CF3 = 667.71; I/YR = 14; and then solve for NPV = $446.01 million c. Total value t=0 = $446.01 million. Value of common equity = $446.01 - $97 = $349.01 million. Price per share = 349.01 / 14 = $24.93

Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Dozier's WACC is 14%. Year 0 1 2 3 FCF ($ millions) NA - 22 19 41 A) What is Dozier's horizon, or continuing, value? (Hint: Find the value of all free cash flows beyond Year 3 discounted back to Year 3.) Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $13,550,000 should be entered as 13.55. B) What is the firm's value today? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $13,550,000 should be entered as 13.55. C) Suppose Dozier has $97 million of debt and 14 million shares of stock outstanding. What is your estimate of the price per share? Round your answer to two decimal places. Write out your answer completely. For example, 0.00025 million should be entered as 250.

a . The horizon date is the date when the growth rate becomes constant. This occurs at the end of Year 2. = II b. 0 1 2 3 rs = 16% gs = 18% gs = 18% gn = 3% 1 1.18 1.3924 1.434172 11.03 = 1.434172 / (0.16-0.03) The horizon, or continuing, value is the value at the horizon date of all dividends expected thereafter. In this problem it is calculated as follows: (1.3924 x 1.03) / (0.16 - 0.03) = 11.03 c. The firm's intrinsic value is calculated as the sum of the present value of all dividends during the supernormal growth period plus the present value of the terminal value. Using your financial calculator, enter the following inputs: CF0 = 0, CF1 = 1.18, CF2 = 1.3924 + 11.03 = 12.42, I/YR = 16, and then solve for NPV = $10.25.

Holt Enterprises recently paid a dividend, D0, of $1.00. It expects to have non-constant growth of 18% for 2 years followed by a constant rate of 3% thereafter. The firm's required return is 16%. A) How far away is the horizon date? I. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2. II. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2. III. The terminal, or horizon, date is infinity since common stocks do not have a maturity date. IV. The terminal, or horizon, date is Year 0 since the value of a common stock is the present value of all future expected dividends at time zero. V. The terminal, or horizon, date is the date when the growth rate becomes non-constant. This occurs at time zero. B) What is the firm's horizon, or continuing, value? Round your answer to two decimal places. Do not round your intermediate calculations. C) What is the firm's intrinsic value today, P̂0? Round your answer to two decimal places. Do not round your intermediate calculations.

D - "The stock's price one year from now is expected to be 5% above the current price" is true, because the stock price is expected to grow at the dividend growth rate.

If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium. a. The expected return on the stock is 5% a year. b. The stock's required return must be equal to or less than 5%. c. The stock's dividend yield is 5%. d. The stock's price one year from now is expected to be 5% above the current price. e. The price of the stock is expected to decline in the future.

B - "Each stock's expected return should equal its required return as seen by the marginal investor" is true, because if the expected return does not equal the required return, then markets are not in equilibrium and buying/selling will occur until the expected return equals the required return.

If markets are in equilibrium, which of the following conditions will exist? a. The expected and required returns on stocks and bonds should be equal. b. Each stock's expected return should equal its required return as seen by the marginal investor. c. All stocks should have the same expected return as seen by the marginal investor. d. Each stock's expected return should equal its realized return as seen by the marginal investor. e. All stocks should have the same realized return during the coming year.

D - $3,500 FCF0 $250 g 5.0% WACC 12.5% FCF1 = FCF0(1 + g) = $262.50 Total corporate value = FCF1/(WACC - g) = $3,500.00

Mooradian Corporation's free cash flow during the just-ended year (t = 0) was $250 million, and its FCF is expected to grow at a constant rate of 5.0% in the future. If the weighted average cost of capital is 12.5%, what is the firm's total corporate value, in millions? a. $2,695 b. $4,130 c. $3,850 d. $3,500 e. $3,255

Picture on phone 0 1 2 3 4 rs=9.5% gs = 15% gs = 15% gs = 15% gn = 6% D1 = 1.2650 D2 = 1.4548 D3 = 1.6730 D4 = 1.7733 = 50.6669* 52.3398 *The horizon value is calculated as $1.6730 (1.06)/(0.095 - 0.06) = $50.66686. Using your financial calculator, enter the following data: CF0 = 0, CF1 = 1.2650, CF2 = 1.4548, CF3 = 52.33983, and I/YR = 9.5; and solve for NPV = = $42.23. It's important to realize that D0 is not included in the stock's value today because the dividend has already been paid. Note that D4 is calculated only to determine the horizon value . To include D4 in the valuation is to double count this dividend because it is already included in the horizon value. Also, note that the horizon value should be discounted in Year 3 and not Year 4. The horizon value is the present value of all dividends received during the constant growth period. In this problem, the horizon value is equal to the present value at Year 3 of all dividends received in Year 4 and thereafter.

Nonconstant Growth Stocks: For many companies, it is not appropriate to assume that dividends will grow at a constant rate. Most firms go through life cycles where they experience different growth rates during different parts of the cycle. For valuing these firms, the generalized valuation and the constant growth equations are combined to arrive at the nonconstant growth valuation equation: Basically, this equation calculates the present value of dividends received during the nonconstant growth period and the present value of the stock's horizon value, which is the value at the horizon date of all dividends expected thereafter. Quantitative Problem 3: Assume today is December 31, 2013. Imagine Works Inc. just paid a dividend of $1.10 per share at the end of 2013. The dividend is expected to grow at 15% per year for 3 years, after which time it is expected to grow at a constant rate of 6% annually. The company's cost of equity (rs) is 9.5%. Using the dividend growth model (allowing for nonconstant growth), what should be the price of the company's stock today (December 31, 2013)? Round your answer to the nearest cent. Do not round intermediate calculations. $ _____ per share

The firm's free cash flow is expected to grow at a constant rate, hence we can apply a constant growth formula to determine the total value of the firm. Firm value = FCF1/(WACC - gFCF) = $125,000,000/(0.13 - 0.03) = $1,250,000,000.00 To find the value of an equity claim upon the company (share of stock), we must subtract out the market value of debt and preferred stock. This firm happens to be entirely equity funded, so this step is unnecessary here. Hence, to find the value of a share of stock, we divide equity value (or in this case, firm value) by the number of shares outstanding. Equity value per share = Equity value/Shares outstanding = $1,250,000,000.00/40,000,000 = $31.25 Each share of common stock is worth $31.25, according to the corporate valuation model

Scampini Technologies is expected to generate $125 million in free cash flow next year, and FCF is expected to grow at a constant rate of 3% per year indefinitely. Scampini has no debt or preferred stock, and its WACC is 13%. If Scampini has 40 million shares of stock outstanding, what is the stock's value per share? Round your answer to two decimal places. Each share of common stock is worth $_____, according to the corporate valuation model.

B

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks are positively correlated, but the correlation coefficient is only 0.6. You have a portfolio that consists of 50% Stock A and 50% Stock B. Which of the following statements is CORRECT? A. The portfolio's beta is greater than 1.2 B. The portfolio's beta is equal than 1.2 C. The portfolio's beta is less than 1.2

C

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks are positively correlated, but the correlation coefficient is only 0.6. You have a portfolio that consists of 50% Stock A and 50% Stock B. Which of the following statements is CORRECT? A. The portfolio's standard deviation is greater than 20%. B. The portfolio's standard deviation is equal to 20%. C. The portfolio's standard deviation is less than 20%.

D - The following calculations show that "A's expected dividend is $0.75 and B's expected dividend is $1.20" is correct. The others are all wrong. A B Price $25 $40 Expected growth 7% 9% Expected return 10% 12% A = P0= D1/(r - g) = D1= P0(r) - P0(g) = $0.75 B = P0= D1/(r - g) = D1= P0(r) - P0(g) = $1.20

Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Price $25 $40 Expected growth 7% 9% Expected return 10% 12% a. The two stocks should have the same expected dividend. b. B's expected dividend is $0.75. c. The two stocks could not be in equilibrium with the numbers given in the question. d. A's expected dividend is $0.75 and B's expected dividend is $1.20. e. A's expected dividend is $0.50.

A - Statement a is true, because if the required return for Stock A is higher than that of Stock B, and if the dividend yield for Stock A is lower than Stock B's, the growth rate for Stock A must be higher to offset this. "If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's" is true, because if the required return for Stock A is higher than that of Stock B, and if the dividend yield for Stock A is lower than Stock B's, the growth rate for Stock A must be higher to offset this.

Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT? a. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's. b. Stock B must have a higher dividend yield than Stock A. c. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's. d. Stock A must have a higher dividend yield than Stock B. e. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.

B - P1 = P0(1 + g) = $54. Therefore, "The stock price is expected to be $54 a share one year from now" is correct. All the other answers are false. P1 = $54.00

The expected return on Natter Corporation's stock is 14%. The stock's dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT? a. The current dividend per share is $4.00. b. The stock price is expected to be $54 a share one year from now. c. The stock's dividend yield is 7%. d. The stock price is expected to be $57 a share one year from now. e. The stock's dividend yield is 8%.

Calculate next year's FCF: FCF1 = EBIT(1 - T) + Depreciation - (Gross capital expenditures + ΔNet operating working capital) FCF1 = $450 + $65 - ($110 + $20) = $385 million Calculate the value of the firm today: VFirm = $385,000,000/(0.086 - 0.045) = $9,390,243,902.44 Calculate the market value of the firm's equity today: MVE = VFirm - (MV of debt and equity) MVE = $9,390,243,902.44 - $2,850,000,000 = $6,540,243,902.44 Calculate the firm's current price per share: P0 = $6,540,243,902.44/180,000,000 = $36.33

The recognition that dividends are dependent on earnings, so a reliable dividend forecast is based on an underlying forecast of the firm's future sales, costs and capital requirements, has led to an alternative stock valuation approach, known as the corporate valuation model. The market value of a firm is equal to the present value of its expected future free cash flows: Free cash flows are generally forecasted for 5 to 10 years, after which it is assumed that the final forecasted free cash flow will grow at some long-run constant rate. Once the firm reaches its horizon date, when cash flows begin to grow at a constant rate, the equation to calculate the continuing value of the firm at that date is: Discount the free cash flows back at the firm's weighted average cost of capital to arrive at the value of the firm today. Once the value of the firm is calculated, the market value of debt and preferred are subtracted to arrive at the market value of equity. The market value of equity is divided by the number of common shares outstanding to estimate the firm's intrinsic per-share value. We present 2 examples of the corporate valuation model. In the first problem, we assume that the firm is a mature company so its free cash flows grow at a constant rate. In the second problem, we assume that the firm has a period of nonconstant growth. Quantitative Problem 1: Assume today is December 31, 2013. Barrington Industries expects that its 2014 after-tax operating income (EBIT(1 - T)) will be $450 million and its 2014 depreciation expense will be $65 million. Barrington's 2014 gross capital expenditures are expected to be $110 million and the change in its net operating working capital for 2014 will be $20 million. The firm's free cash flow is expected to grow at a constant rate of 4.5% annually. Assume that its free cash flow occurs at the end of each year. The firm's weighted average cost of capital is 8.6%; the market value of the company's debt is $2.85 billion; and the company has 180 million shares of common stock outstanding. The firm has no preferred stock on its balance sheet and has no plans to use it for future capital budgeting projects. Using the corporate valuation model, what should be the company's stock price today (December 31, 2013)? Round your answer to the nearest cent. Do not round intermediate calculations. $ ______ per share

E

The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT? a. Stock Y must have a higher dividend yield than Stock X. b. The stocks must sell for the same price. c. If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X. d. If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price. e. If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.

B

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0, and the market risk premium, rm-rRF, is positive. Which of the following statements is correct? A. If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's. B. If Stock A's required return is 11%, the market risk premium is 5%. C. Stock B's required rate of return is twice that of Stock A. D. If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's. E. If Stock B's required return is 11%, the market risk premium is 5%.

(1) equal to (2) below (3) an infinite (4) start-up (5) mature

The value of a share of common stock depends on the cash flows it is expected to provide, and those flows consist of the dividends the investor receives each year while holding the stock and the price the investor receives when the stock is sold. The final price includes the original price paid plus an expected capital gain. The actions of the marginal investor determine the equilibrium stock price. Market equilibrium occurs when the stock's price is *(1) *its intrinsic value. If the stock market is reasonably efficient, differences between the stock price and intrinsic value should not be very large and they should not persist for very long. When investing in common stocks, an investor's goal is to purchase stocks that are undervalued (the price is *(2) *the stock's intrinsic value) and avoid stocks that are overvalued. The value of a stock today can be calculated as the present value of *(3) *stream of dividends: This is the generalized stock valuation model. We will now look at 3 different situations where we can adapt this generalized model to each of these situations to determine a stock's intrinsic value: 1. Constant Growth Stocks; 2. Zero Growth Stocks; 3. Nonconstant Growth Stocks. Constant Growth Stocks: For many companies it is reasonable to predict that dividends will grow at a constant rate, so we can rewrite the generalized model as follows: This is known as the constant growth model or Gordon model, named after Myron J. Gordon who developed and popularized it. There are several conditions that must exist before this equation can be used. First, the required rate of return, rs, must be greater than the long-run growth rate, g. Second, the constant growth model is not appropriate unless a company's growth rate is expected to remain constant in the future. This condition almost never holds for *(4) *firms, but it does exist for many *(5) *companies.

E

Which of the following assumptions would cause the constant growth stock valuation model to be invalid? a. The growth rate is zero. b. The growth rate is negative. c. The required rate of return is greater than the growth rate. d. The required rate of return is more than 50%. e. None of the above assumptions would invalidate the model.

A

Which of the following statements is CORRECT? a. The stock valuation model, P0 = D1/(rs − g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate. b. The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time. c. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate. d. If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. e. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.

Vp = Dp/rp Vp = $1.80/0.10 = $18.00

Zero Growth Stocks: The constant growth model is sufficiently general to handle the case of a zero growth stock, where the dividend is expected to remain constant over time. In this situation, the equation is: P hat 0 = D / Rs Note that this is the same equation developed in Chapter 5 to value a perpetuity, and it is the same equation used to value a perpetual preferred stock that entitles its owners to regular, fixed dividend payments in perpetuity. The valuation equation is simply the current dividend divided by the required rate of return. Quantitative Problem 2: Carlysle Corporation has perpetual preferred stock outstanding that pays a constant annual dividend of $1.80 at the end of each year. If investors require an 10% return on the preferred stock, what is the price of the firm's perpetual preferred stock? Round your answer to the nearest cent. Do not round intermediate calculations. $ ______ per share.