Chapter 13 - Equity Valuation

Tri-coat Paints has a current market value of $41 per share with earnings of $3.64. What is the present value of its growth opportunities (PVGO) if the required return is 9%?

$0.56

Radverb Inc. paid a dividend of $2.00 last year. The company expects to increase the dividend at a constant rate of 2% per year, indefinitely. The current price for the stock is $34. What will the price of Radverb's stock be if the required return falls by half (by 50%)?

$102.00 P0 = ( (D0 (1+g)) / (Ke - g)

Shocktown Inc. paid a dividend of $1.20 last year. The company expects to increase the dividend at a constant rate of 5% per year, indefinitely. The stock price is $10.68 currently, with a beta of 1.2. The market risk premium is 9% and the risk-free rate is 6%. What will the price of Shocktown's stock be if the market risk premium falls to 8%?

$11.89

Dogtown Inc. paid a dividend of $1.40 last year. The company expects to increase the dividend at a constant rate of 2% per year, indefinitely. The stock price is $14.28 currently. The market risk premium is 10% and the risk-free rate is 4%. What will the price of Dogtown's stock be if its beta rises by 20%?

$12.31

Bigtown Inc. will pay a dividend of $1.50 next year. The stock price is $13.39 currently, with a beta of 0.9. The market risk premium is 8% and the risk-free rate is 6%. What will the price of Bigtown's stock be if the dividend growth rate doubles?

$16.30

Eagle Products' EBIT is $300, its tax rate is 21%, depreciation is $20, capital expenditures are $60, and the planned increase in net working capital is $30. What is the free cash flow to the firm?

$167 FCFF = EBIT(1 − tc) + Depreciation − Capital expenditures − Increase in NWC = $300 × (1 − 0.21) + $20 − $60 − $30 = $167

A stock has a current price of $24. Investors require a 10% return on this constant dividend stock. The risk-free rate is 2% and the expected return on the market is 12%. If the beta on this stock increases by 40%, what is the new price of this stock?

$18.18

A common stock pays an annual dividend per share of $2.10. The risk-free rate is 7% and the risk premium for this stock is 4%. If the annual dividend is expected to remain at $2.10, what is the value of the stock?

$19.09

FinCorp's free cash flow to the firm is reported as $205 million. The firm's interest expense is $22 million. Assume the tax rate is 35% and the net debt of the firm increases by $3 million. What is the market value of equity if the FCFE is projected to grow at 3% indefinitely and the cost of equity is 12%?

$2,152 million FCFE1 = FCFF - Interest expenses (1 - tc) + Increases in net debt FCFE = $205 - $22(1 - 0.35) + $3 = $193.70(million) Value = 193.70 / (0.12 - 0.03) = $2,152.22 (million)

ABC Inc. just paid a dividend of $1.00 this year. The stock price is $15.43 currently. The market risk premium is 15% and the risk-free rate is 6%. What will the price of ABC's stock be if the dividend growth increases by 25%?

$22

Lowgro Inc. stock paid a dividend of $1.20 over the past year. The dividend is not expected to grow over the next five years. After the five-year no-growth period, the dividends are expected to grow at a 6% rate, indefinitely. If investors require a 10% return on Logrow stock, what is its current price?

$24.29

Microshort Inc. stock paid a dividend of $1.00 over the past year. The dividend is expected to grow at a rate of 20% over the next three years. After the three-year high-growth period, the dividends are expected to grow at a 10% rate, indefinitely. If investors require a 15% return on Microshort stock, what is its current price?

$28.25

The risk-free rate of return is 5%, the required rate of return on the market is 10%, and High-Flyer stock has a beta coefficient of 1.5. If the dividend per share expected during the coming year, D1, is $2.50 and g = 4%, at what price should a share sell?

$29.41

Deployment Specialists pays a current (annual) dividend of $1 and is expected to grow at 20% for two years and then at 4% thereafter. If the required return for Deployment Specialists is 8.5%, what is the intrinsic value of its stock?

$30.59

Bosstown Inc. paid a dividend of $1.00 last year. The company expects to increase the dividend at a constant rate of 6% per year, indefinitely. The required return for Bosstown stock is 11.6%% and the risk-free rate is 6%. What will the price of Bosstown's stock be if the required return falls to 8%?

$53.00

Public Imagination, Ltd. has an ROE of 16%, a plowback ratio of 75%, earnings for next year of $2 per share, and its stock has a required return of 18%. What is the current stock price for PIL?

$8.33

Public Imagination, Ltd. has an ROE of 16%, a plowback ratio of 75%, earnings for next year of $2 per share, and its stock has a required return of 18%. What is the PVGO for PIL?

-$2.78

A firm has current assets that could be sold for their book value of $10 million. The book value of its fixed assets is $60 million, but they could be sold for $90 million today. The firm has total debt with a book value of $40 million, but interest rate declines have caused the market value of the debt to increase to $50 million. What is this firm's market-to-book ratio?

1.67

A firm's stock price is currently $48 per share. The company will pay a $3 dividend next year and investors require a 10% rate of return for investing in this stock. What is the growth rate that investors anticipate for this company's dividends?

3.75% g = r - (D1/P0) 10% - (3/48) = 3.75%

A firm pays a current dividend of $1, which is expected to grow at a rate of 5% indefinitely. If the current value of the firm's shares is $35, what is the required return applicable to the investment based on the constant-growth dividend discount model (DDM)?

8%

Jand, Inc., currently pays a dividend of $1.22, which is expected to grow indefinitely at 5%. If the current value of Jand's shares based on the constant-growth dividend discount model is $32.03, what is the required rate of return?

8.99%

A firm with a low plowback ratio, relative to its peers, is more likely to be considered which of the following?

A value firm

The product of what two forecasts is the estimate of the end-of-period level of the market? Historical Profits for the Five Most Recent Periods Corporate Profits for the Coming Period An Estimate of the Revenue Multiplier An Estimate of the Earnings Multiplier

Corporate Profits for the Coming Period An Estimate of the Earnings Multiplier

Chiptech, Inc. paid a $3 dividend last year and is expected to grow the dividend at 10% for the next 2 years. The dividend will then grow at a constant rate of 4%, thereafter. If investors require a return of 12% on this stock, what is Chiptech's current price?

D0 = 3 D1 = 3 * 1.1 = 3.3 D2 = 3 * 1.12 = 3.63 D3 = 3.63 * 1.04 = 3.7752 P2 = D3/(Required Rate - Groeth rate) P2 = 3.7752/(12% - 4%) P2 = 47.19 Price of the stock = 3.3/(1.12) + 3.63/(1.12)2 + 47.19/ (1.12)2 Price of Stock = 2.946429 + 2.893814 + 37.61958 Price of Stock = $43.46

Which valuation method is most closely associated with the process of determining the intrinsic value of a stock?

Dividend Discount Model

_____ management is the practice of using flexibility in accounting rules to manipulate the apparent profitability of the firm.

Earnings

The PEG ratio adjusts the P/E ratio, the most commonly used ratio in valuation by comparables, by including what factor in the calculation?

Earnings growth

Increasing the market risk premium will cause the price of the stock to do what?

Fall

Company A and Company B have the same P/E ratio, but Company A has a lower PEG ratio. Company A must have a slower growth rate for earnings than Company B.

False

The Price-to-Earnings ratio can be used as a valuation benchmark even in cases where a firm has negative earnings.

False

True or false: Book value provides a useful measure of the minimum value of a firm.

False

Which of the following are typically used in the denominator of the price-to-cash-flow ratio? Free Cash Flow EBITDA Taxable Income Net Revenue Operating Cash Flow

Free Cash Flow Operating Cash Flow

_____ value is the present value of a firm's expected future net cash flows discounted by the required rate of return.

Intrinsic

Deployment Specialists pays a current (annual) dividend of $1 and is expected to grow at 20% for two years and then at 6% thereafter. If the required return for Deployment Specialists is 8.5%, what is the intrinsic value of its stock?

Intrinsic value $54.19 Intrinsic value = V0 = [D1/(1+k)] + [D2/(1+k)^2] +...+ [(DH+PH)/(1+k)^H] = [$1*1.20/(1+0.085)] + [($1*1.20)^2/(1+0.085)^2] +...+ [($1*1.20)^2 * 1.06)/(1+0.085-0.06) * (1+0.085)^2]

Low P/B, P/E, and high dividend yield are often used as indicators for "value" stocks. Which of the following attributes enhance these value indicators, but are not consistent with the company's stock being a true investment value? (check all that apply) Large dividends in firm with sizable inside ownership Stock price falls in line with broad market weakness associated with the business cycle Inflation boosts earnings Poor growth prospects Earnings management boosts earnings following previous weak reported earnings

Large dividends in firm with sizable inside ownership Poor growth prospects Earnings management boosts earnings following previous weak reported earnings

Consider a company with a P/E ratio of 15, in an industry with an average P/E ratio of 20, and the same required return (k) as the industry average. This company is potentially an appropriate addition to an investor's portfolio for which of the following reasons? The firm's PVGO is higher than the industry average. The firm's growth prospects are stronger than average for the industry The firm's PVGO is lower than the industry average. The stock could be considered a value investment.

The stock could be considered a value investment.

The MoMi Corporation's cash flow from operations before interest and taxes was $2 million in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen, the firm will have to invest an amount equal to 20% of pretax cash flow each year. The tax rate is 21%. Depreciation was $200,000 in the year just ended and is expected to grow at the same rate as the operating cash flow. The appropriate market capitalization rate for the unleveraged cash flow is 12% per year, and the firm currently has debt of $4 million outstanding. Use the free cash flow approach to calculate the value of the firm and the firm's equity.

Value of the firm $18,330,000 Value of the firm's equity $14,330,000 Explanation: Before-tax cash flow from operations $2,100,000 Depreciation 210,000 ---------------------------------------------------- Taxable Income 1,890,000 Taxes (@ 21%) 396,900 ---------------------------------------------------- After-tax unleveraged income 1,493,100 After-tax cash flow from operations (After-tax unleveraged income + depreciation) 1,703,100 New investment (20% of cash flow from operations) 420,000 ---------------------------------------------------- Free cash flow (After-tax cash flow from operations - new investment) $1,283,100 The value of the firm (i.e., debt plus equity) is: V0 = FCFF1/(k-g) = $1,283,000 / (0.12-0.05) = $18,330,000 Since the value of the debt is $4 million, the value of the equity is $14,330,000.

Two valuation approaches commonly applied to the aggregate stock market include (check the ones that apply) an earnings multiple approach a price to sales multiple approach a free cash flow model a dividend discount model

a dividend discount model an earnings multiple approach

Sisters Corp. expects to earn $6 per share next year. The firm's ROE is 15% and its plowback ratio is 60%. The firm's market capitalization rate is 10%. a. Calculate the price with the constant dividend growth model. b. Calculate the price with no growth. c.

a. $240 b. $60 c. 180

Miltmar Corporation will pay a year-end dividend of $4, and dividends thereafter are expected to grow at the constant rate of 4% per year. The risk-free rate is 4%, and the expected return on the market portfolio is 12%. The stock has a beta of 0.75. a. Calculate the market capitalization rate. b. What is the intrinsic value of the stock?

a. 10% b. $66.67

a. Computer stocks currently provide an expected rate of return of 16%. MBI, a large computer company, will pay a year-end dividend of $2 per share. If the stock is selling at $50 per share, what must be the market's expectation of the growth rate of MBI dividends? b. If dividend growth forecasts for MBI are revised downward to 5% per year, what will be the price of the MBI stock? c. What (qualitatively) will happen to the company's price-earnings ratio?

a. 12% b. $18.18 c. The P/E ratio will decrease.

The market capitalization rate for Admiral Motors Company is 8%. Its expected ROE is 10% and its expected EPS is $5. The firm's plowback ratio is 60%. a. Calculate the growth rate. b. What will be its P/E ratio?

a. 60% b. 20

The FI Corporation's dividends per share are expected to grow indefinitely by 5% per year. a. If this year's year-end dividend is $8 and the market capitalization rate is 10% per year, what must the current stock price be according to the dividend discount model? b. If the expected earnings per share are $12, what is the implied value of the ROE on future investment opportunities? c. How much is the market paying per share for growth opportunities (that is, for an ROE on future investments that exceeds the market capitalization rate)?

a. Current stock price $160 b. Value on ROE 15% c. Amount per share $40

The risk-free rate of return is 8%, the expected rate of return on the market portfolio is 15%, and the stock of Xyrong Corporation has a beta coefficient of 1.2. Xyrong pays out 40% of its earnings in dividends, and the latest earnings announced were $10 per share. Dividends were just paid and are expected to be paid annually. You expect that Xyrong will earn an ROE of 20% per year on all reinvested earnings forever. a. What is the intrinsic value of a share of Xyrong stock? b-1. If the market price of a share is currently $100, and you expect the market price to be equal to the intrinsic value one year from now, calculate the price of the share after one year from now. b-2. What is your expected one-year holding-period return on Xyrong stock?

a. Intrinsic value $101.82 b-1. Price $114.04 b-2. Expected one-year holding-period return 18.52%

The market consensus is that Analog Electronic Corporation has an ROE of 9% and a beta of 1.25. It plans to maintain indefinitely its traditional plowback ratio of 2/3. This year's earnings were $3 per share. The annual dividend was just paid. The consensus estimate of the coming year's market return is 14%, and T-bills currently offer a 6% return. a. Find the price at which Analog stock should sell. b. Calculate the P/E ratio. c. Calculate the present value of growth opportunities. d. Suppose your research convinces you Analog will announce momentarily that it will immediately reduce its plowback ratio to 1/3. Find the intrinsic value of the stock.

a. Price $10.60 b. Leading 3.33 Trailing 3.53 c. PVGO (9.28) d. $15.85

Even Better Products has come out with an even better product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of 0.30. Its earnings this year will be $2 per share. Investors expect a 12% rate of return on the stock. a. At what price and P/E ratio would you expect the firm to sell? b. What is the present value of growth opportunities? c. What would be the P/E ratio and the present value of growth opportunities if the firm planned to reinvest only 20% of its earnings?

a. Price $23.33 P/E ratio 11.67 b. PVGO $6.67 c. P/E ratio 10.0 PVGO $3.33

a. MF Corp. has an ROE of 16% and a plowback ratio of 50%. If the coming year's earnings are expected to be $2 per share, at what price will the stock sell? The market capitalization rate is 12%. b. What price do you expect MF shares to sell for in three years?

a. Price $25 b. Price $31.50

The stock of Nogro Corporation is currently selling for $10 per share. Earnings per share in the coming year are expected to be $2. The company has a policy of paying out 50% of its earnings each year in dividends. The rest is retained and invested in projects that earn a 20% rate of return per year. This situation is expected to continue indefinitely. a. Assuming the current market price of the stock reflects its intrinsic value as computed using the constant-growth DDM, what rate of return do Nogro's investors require? b. By how much does its value exceed what it would be if all earnings was paid as dividends and nothing were reinvested? c. If Nogro were to cut its dividend payout ratio to 25%, what would happen to its stock price? d. If Nogro eliminated the dividend, what would happen to its stock price?

a. Rate of return 20% b. PVGO $0 c. Stock price would be unaffected d. Stock price would be unaffected

Book value provides a useful benchmark in the Price to Book ratio, because

book value includes the accumulated retained earnings for the firm

The constant growth Dividend Discount Model indicates that the stock value will be higher, other things equal, for (check all that apply) higher expected dividend per share higher required return on equity lower required return on equity higher expected growth rate of dividends lower expected growth rate of dividends lower expected dividend per share

higher expected dividend per share lower required return on equity higher expected growth rate of dividends

An assumption of the constant growth model is that the stock price grows at the same rate as

its dividends.

The constant growth model is used within the multistage growth model because

the timeline is infinite