Chapter 9 Finance 310

Gupta Corporation is undergoing a restructuring, and its free cash flows are expected to vary considerably during the next few years. However, the FCF is expected to be $85.00 million in Year 5, and the FCF growth rate is expected to be a constant 6.5% beyond that point. The weighted average cost of capital is 12.0%. What is the horizon (or continuing) value (in millions) at t = 5?

a. $1,662 b. $2,041 c. $1,234 d. $1,646 e. $1,432 FCF5=$85.00 g=6.5% WACC=12.0% FCF6 = FCF5(1 + g) =$90.5250 HV5 = FCF6/(WACC - g) =$1,646 Correct Answer: D

The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company's beta is 1.65, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company's current stock price, P0? Do not round intermediate calculations.

a. $12.66 b. $11.72 c. $13.60 d. $10.08 e. $13.83 D0=$0.75 b=1.65 rRF=4.0% RPM=5.0% g=5.5% D1 = D0(1 + g) =$0.79125 rS = rRF + b(RPM) =12.25% P0 = D1/(rS - g) =$11.72 Correct Answer: B

Check My Work A share of common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 14.2%, then what is the stock price?

a. $12.70 b. $11.98 c. $10.66 d. $12.10 e. $14.61 Last dividend (D0)=$1.00 Long-run growth rate=5.4% Required return=14.2% D1 = D0(1 + g) =$1.054 P0 = D1/(rS - g)$11.98 Correct Answer: B

You have been assigned the task of using the corporate, or free cash flow, model to estimate Petry Corporation's intrinsic value. The firm's WACC is 10.00%, its end-of-year free cash flow (FCF1) is expected to be $70.0 million, the FCFs are expected to grow at a constant rate of 5.00% a year in the future, the company has $200 million of long-term debt and preferred stock, and it has 30 million shares of common stock outstanding. Assume the firm has zero non-operating assets. What is the firm's estimated intrinsic value per share of common stock? Do not round intermediate calculations.

a. $34.40 b. $48.80 c. $40.00 d. $49.60 e. $36.80 FCF1=$70.00 Constant growth rate=5.0% WACC=10.0% Debt & preferred stock=$200 Shares outstanding=30 Total firm value = FCF1/(WACC - g) =$1,400.00 Less: Value of debt & preferred stock-$200.00 Value of equity=$1,200.00 Number of shares=30 Value per share = Equity value/Shares =$40.00 Correct Answer: C

The Ramirez Company's last dividend was $1.75. Its dividend growth rate is expected to be constant at 24% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rS) is 12%. What is the best estimate of the current stock price? Do not round intermediate calculations.

a. $52.47 b. $41.98 c. $45.34 d. $36.94 e. $31.90 Correct Answer: B

The Francis Company is expected to pay a dividend of D1 = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 0.85, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company's current stock price? Do not round intermediate calculations.

a. $54.21 b. $46.73 c. $49.53 d. $47.66 e. $51.40 D1=$1.25 b=0.85 rRF=4.00% RPM=5.50% g=6.00% rS = rRF + b(RPM) =8.75% P0 = D1/(rS - g)$46.73 Correct Answer: B

Sorenson Corp.'s expected year-end dividend is D1 = $4.00, its required return is rS = 11.00%, its dividend yield is 6.00%, and its growth rate is expected to be constant in the future. What is Sorenson's expected stock price in 7 years, i.e., what is P̃7? Do not round intermediate calculations.

a. $87.24 b. $90.05 c. $93.81 d. $85.36 e. $76.92 Next expected dividend = D1 =$4.00 Required return=11.0% Dividend yield = D1/P0 =6.0% Find the growth rate: g = rs - Div yield =5.0% Find P0 = D1/(rs - g) =$66.67 Years in the future=7 P̃7 = P0(1 + g)7=$93.81 Correct Answer: C

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%, then which of the following statements is CORRECT?

a. The company's dividend yield 5 years from now is expected to be 10%. b. The constant growth model cannot be used because the growth rate is negative. c. The company's expected capital gains yield is 5%. d. The company's current stock price is $20. e. The company's expected stock price at the beginning of next year is $9.50. 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. Correct Answer: E

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? Required Return A= 10% B=12% Market Price A=$25 B=$40 Expected Growth A=7% B=9%

a. These two stocks should have the same expected return. b. These two stocks must have the same expected capital gains yield. c. These two stocks should have the same price. d. These two stocks must have the same expected year-end dividend. e. These two stocks must have the same dividend yield. The following calculations show that "These two stocks must have the same dividend yield" is correct. All the others are wrong. Correct Answer: E

If a given investor believes that a stock's expected return exceeds its required return, then the investor most likely believes that

a. dividends are not likely to be declared. b. management is probably not trying to maximize the price per share. c. the stock is experiencing supernormal growth. d. the stock should be sold. e. the stock is a good buy. Correct Answer: E