Chapter 9

Super Carpeting Inc. (SCI) just paid a dividend (D₀) of $3.12 per share, and its annual dividend is expected to grow at a constant rate (g) of 6.50% per year. If the required return (rss) on SCI's stock is 16.25%, then the intrinsic value of SCI's shares is _____ per share.

$34.08 P0= D1/(rs-g) D1= D0* (1+g) = 3.12*(1+6.50%) =3.3228 P0= D1/(rs-g) =3.3228/(16.25%-6.50%) =34.08

What is the expected dividend yield for Portman's stock today? 8.33% 10.08% 10.41% 11.45%

10.41% Dividend Yield = D1/P0 2.23//21.43 =0.1041 or 10.41%

If Larry exercises the provisions in the corporate charter to protect his stake, his investment value in the firm will become ___

103,200 If the company's charter has a preemptive right, Larry would have the opportunity to buy 500 of the new shares (10.00% of the new issue), because he currently holds a 10.00% stake in the firm. If Larry buys 500 new shares, his investment will be: Investment Value = (Existing Price*Existing Shares)+(New Price*New Shares) =($43*2000 shares) + ($34.40*500 shares) =$86,000 + 17,200 =103,200 If there is a preemptive right and Larry buys new shares, he will hold 2,500 shares/25,000 shares = 10.00% of the company. Thus, he will have averted dilution.

Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $2.25 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 $17.00 per share, what is the expected rate of return? 1,563.53% 692.65% 612.49% 19.24%

19.24% rs = expected dividend yield (D1/P0) + Expected Growth Rate (g) =(2.25/17.00)+6% =0.1924 or 19.24%

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 Co. Robert has the following information available: •Pan Asia Mining Co.'s stock (Ticker: PAMC) is trading at $15.00.•The company's stock is expected to pay a year-end dividend of $0.72 that is expected to grow at a certain rate.•The stock's expected rate of return is 7.20%. Based on the information just given, what will be Robert's forecast of PAMC's growth rate? 7.15% 3.60% 1.99% 2.40%

2.40% (g) = rs - expected dividend yield (D1/P0) =0.072-(0.72/15) =0.072 - 0.0480 =0.0240 or 2.40%

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 $43.00 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 $34.40 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 _______

86,000 = shares outstanding * price per share = 20,000*43 =86,000 82,560 New Share Value=New Market Value/Total Outstanding Shares =$1,032,000/25,000 shares =$41.28 per share Therefore, Larry's investment will be worth $82,560 ($41.28 per share x 2,000 shares). His investment will be diluted by $3,440, and now he holds only 8.00%

Use the constant growth model to calculate the appropriate values to complete the following statements about Super Carpeting Inc.: •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.

9.75% DY= D1/P0 =3.3228/34.08 =0.09750 =9.75% 36.30 D2= D0*(1+g)^2 =D1*(1+g) =3.3228*(1+6.50%) =3.5388 P1=D2/(rs-g) =3.5388/(16.25%-6.50%) =36.30 per share 6.51% CGY= (P1-P0)/P0 CGY= (36.30-34.08)/34.08 =0.0651 or 6.51% If you add 9.75% and 6.51%, you'll get 16.26%. Thus, if markets are in equilibrium, the expected rate of return will be equal to the rate of return on a stock: rˆsr̂s = rss.

You can estimate the value of a company's stock using models such as the corporate valuation model and the dividend discount model. Which of the following companies would you choose to evaluate if you were using the corporate valuation model to estimate the value of the company's stock? A company that has a stable distribution policy. A company that is not expected to distribute any earnings to its stockholders for the next few years.

A company that is not expected to distribute any earnings to its stockholders for the next few years.

Benjamin Graham, the father of value investing, once said, "In the short run, the market is a voting machine, but in the long run, the market is a weighing machine." In this quote, Benjamin Graham was referring to the key difference between the "price" and the "value" of a security. In November 2006, Citigroup's stock (NYSE: C) was trading at $49.59. Following the credit crisis of 2007-2008 and by the end of October 2009, Citigroup's stock price had plummeted to $4.27. Several banks went under, and others saw their stock prices lose more than 60% of their value. Based on your understanding of stock prices and intrinsic values, which of the following statements is true? A stock's intrinsic value is based on true risk in the company. A stock's market price is based only on true investor returns.

A stock's intrinsic value is based on true risk in the company.

Consider this case: The CEO of EchoStar Communications, Charlie Ergen, owned around 5% 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 are not issued with the purpose of providing super voting rights to a certain class of investors. Classified shares have super voting rights, which give more control to a certain class of investors.

Classified shares have super voting rights, which give more control to a certain class of investors.

As companies evolve, certain factors can drive sudden growth. This may lead to a period of nonconstant, or variable, growth. This would cause the expected growth rate to increase or decrease, thereby affecting the valuation model. For companies in such situations, you would refer to the variable, or nonconstant, growth model for the valuation of the company's stock. Consider the case of Portman Industries: Portman Industries just paid a dividend of $1.92 per share. The company expects the coming year to be very profitable, and its dividend is expected to grow by 16.00% over the next year. After the next year, though, Portman's dividend is expected to grow at a constant rate of 3.20% per year. Assuming that the market is in equilibrium, use the information just given to complete the table.

Dividends one year from now 2.23 =rx= rrf + (rm-rrf)bx =4%+(4.80%)*2.00 =13.60% D1= D0 * (1+gs) = 1.92 * (1+16%) =2.23 D2= D1*(1+gn) =2.23*(1+3.20%) =2.30 per share Horizon Value 22.12 P1= D2/(rs-gn) = 2.30/(13.60%-3.20%) =22.12 per share Intrinsic Value 21.43 P0= D1/(1+rs)^1 + P1/(1+rs)^1 P0=(2.23/(1+13.60%))+(22.12/(1+13.60%)) =21.43

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 2.70% 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, 20, and 50 years from now (D10, D20, D50). Assume that the stock's required return (rss) is 8.40%.

Dt= D0 (1 + g)^t D10= $1.00 × (1 + 0.027)^10=$1.3053 D20= $1.00 × (1 + 0.027)^20=$1.7038 D50= $1.00 × (1 + 0.027)^50=$3.7890

Larry Nelson holds 1,000 shares of General Electric (GE) common stock. As a stockholder, he has the right to be involved in the election of its directors, who are responsible for managing the company and achieving the company's objectives. True or False: Larry can invest in another company that is selling class A stocks to the public, and class B shares will be retained by company insiders. This will help the founders maintain control in the company.

False

Which of the following statements is true? 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. 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.

Walter's dividend is expected to grow at a constant growth rate of 6.00% per year. What do you expect to happen to Walter's expected dividend yield in the future? It will decrease. It will increase. It will stay the same.

It will stay the same.

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.

Using the orange curve (square symbols), plot the present value of each of the expected future dividends for years 10, 20, and 50. The resulting curve will illustrate how the PV of a particular dividend payment will decrease depending on how far from today the dividend is expected to be received.

Rounding the values of the discounted dividends to their nearest tenth (or closest possible point), you should have plotted the points on the graph at (10, $0.6), (20, $0.3), and (50, $0.1).

Which of the following describe the reason(s) why maximization of intrinsic stock value benefits society? Check all that apply. Successful companies higher more employees. Stock price maximization requires efficient, low-cost businesses. Most investors prefer companies that can raise prices beyond reasonable levels. Successful companies can avoid raising external funds in the financial markets.

Successful companies higher more employees. Stock price maximization requires efficient, low-cost businesses.

Which of the following statements is true about the constant growth model? The constant growth model can be used if a stock's expected constant growth rate is less than its required return. The constant growth model can be used if a stock's expected constant growth rate is more than its required return.

The constant growth model can be used if a stock's expected constant growth rate is less than its required return.

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

This scenario is an example of ______. Larry could be protected if the firm's corporate charter includes a _________ provision.

dilution preemptive right