FIN3100 CHPT 9

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. A's expected dividend is $0.63 and B's expected dividend is $1.20. b. The two stocks could not be in equilibrium with the numbers given in the question. c. The two stocks should have the same expected dividend. d. B's expected dividend is $0.75. e. A's expected dividend is $0.50.

A. 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) = $0.63 B = P0= D1/(r - g) = D1= P0(r) - P0(g) = $1.20

According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash flows during the subsequent constant growth period. a. True b. False

A. TRUE

The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond. a. True b. False

A. TRUE

Tresnan Brothers is expected to pay a $1.7 per share dividend at the end of the year (i.e., D1 = $1.7). The dividend is expected to grow at a constant rate of 4% a year. The required rate of return on the stock, rs, is 16%. What is the stock's current value per share? Round your answer to two decimal places. $

According to Gordon Growth Model: Price of Stock (P) = D1​​ / r − g D1 = Expected dividend next year = $1.7 r = required rate of return = 16% = 0.016 g = Constant growth rate expected for dividends = 4% = 0.04 P = $1.7 / ( 0.16 - 0.04) = $1.7 / 0.12 = $14.17 Stock's current value per share is $14.17

What will be the nominal rate of return on a perpetual preferred stock with a $100 par value, a stated dividend of 9% of par, and a current market price of (a) $52.00, (b) $90.00, (c) $114.00, and (d) $144.00? Round your answers to two decimal places.

Answer a. Dividend per share = 100% * 9% = $9 Value of Preferred Stock = $55 Cost of preferred Stock = 9 /52 Cost of preferred Stock = 0.17307 Cost of preferred Stock = 17.31% Answer b. Dividend per share = 100% * 9% = $9 Value of Preferred Stock = $90 Cost of preferred Stock = 9 /90 Cost of preferred Stock = 0.1 Cost of preferred Stock = 10% Answer c. Dividend per share = 100% * 9% = $9 Value of Preferred Stock = $114 Cost of preferred Stock = 9 /114 Cost of preferred Stock = 0.0789 Cost of preferred Stock = 7.89% Answer d. Dividend per share = 100% * 9% = $9 Value of Preferred Stock = $144 Cost of preferred Stock = 9 /144 Cost of preferred Stock = 0.0625 Cost of preferred Stock = 6.25%

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/$25 Expected growth (constant)10%/5% Required return 15%/15% a. The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist. b. Currently the two stocks have the same price, but over time Stock B's price will pass that of A. c. Stock A's expected dividend at t = 1 is only half that of Stock B. d. Since Stock A's growth rate is twice that of Stock B, Stock A's future dividends will always be twice as high as Stock B's. e. Stock A has a higher dividend yield than Stock B.

Answer: e.Stock A's expected dividend at t = 1 is only half that of Stock B. Dividend of stock A: $25=D/(15%-10%) $25*5%=D D=$1.25 Dividend of stock B: $25=D/(15%-5%) $25*10%=D D=$2.5

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 stock's dividend yield is 5%. b. The price of the stock is expected to decline in the future. c. The stock's price one year from now is expected to be 5% above the current price. d. The stock's required return must be equal to or less than 5%. e. The expected return on the stock is 5% a year.

C. "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.

Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? X/Y Price $25/$25 Expected dividend yield 5%/3% Required return 12%/10% a. Stock Y pays a higher dividend per share than Stock X. b. Stock Y has a lower expected growth rate than Stock X. c. Stock X pays a higher dividend per share than Stock Y. d. Stock Y has the higher expected capital gains yield. e. One year from now, Stock X should have the higher price.

C. Dividend = Yield × Price: X Dividend = $1.25 Y dividend = $0.75 Stock X has a dividend yield of 5% versus a dividend yield of 3% for Y. Since they both have the same stock price, X must pay a higher dividend.

Based on the corporate valuation model, Morgan Inc.'s total corporate value is $200 million. The balance sheet shows $90 million of notes payable, $30 million of long-term debt, $40 million of preferred stock, and $100 million of common equity. The company has 10 million shares of stock outstanding. What is the best estimate of the stock's price per share? a. $4.12 b. $3.88 c. $4.00 d. $3.80 e. $3.36

C. $4.00 Enterprise value = Equity value+ MV of debt+ MV of preferred stock+ Notes payable 200 = Equity value+30+40+90 (add to get 160, 200-160) Equity value = 40 share price = equity value/number of shares share price = 40/10 share price = 4

Weston Corporation just paid a dividend of $3.5 a share (i.e., D0 = $3.5). The dividend is expected to grow 7% a year for the next 3 years and then at 5% a year thereafter. What is the expected dividend per share for each of the next 5 years? Round your answers to two decimal places. D1 = $ D2 = $ D3 = $ D4 = $ D5 = $

Calculation of dividend for 5 years: D1= D0(1+growth)= 3.5(1+0.07)= $3.75 D2= D1(1+growth)= 3.75(1+0.07)= $4.01 D3= D2(1+growth)= 4.01(1+0.07)= $4.29 D4= D3(1+growth)= 4.29(1+0.05)=$4.50 D5= D4(1+growth)=4.42(1+0.05)=$4.73

A stock is expected to pay a dividend of $1.50 at the end of the year (i.e., D1 = $1.50), and it should continue to grow at a constant rate of 4% a year. If its required return is 14%, what is the stock's expected price 4 years from today? Round your answer to two decimal places. Do not round your intermediate calculations.

Current price=D1/(Required return-Growth rate) =1.5/(0.14-0.04) =15 P5=Current price*(1+Growth rate)^4 =15*(1.04)^4 =$17.55(Approx)

Ackert Company's last dividend was $4.00. The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (rs) is 12.0%. What is the best estimate of the current stock price? a. $87.00 b. $89.87 c. $104.21 d. $95.61 e. $80.31

D1=(4*1.015)=$4.06 D2=(4.06*1.015)=$4.1209 Value after year 2=(D2*Growth rate)/(Required return-Growth rate) (4.1209*1.08)/(0.12-0.08)=$111.2643 Hence current stock price=Future dividends*Present value of discounting factor(rate%,time period) =4.06/1.12+4.1209/1.12^2+111.2643/1.12^2 which is equal to =$95.61(Approx)

Agarwal Technologies was founded 10 years ago. It has been profitable for the last 5 years, but it has needed all of its earnings to support growth and thus has never paid a dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's forecast of the future dividend stream, along with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value? Year 0/1/2/3/4/5/6 Growth rate NA/NA/NA/NA/30%/15.00%/8.00% Dividends$0.000/$0.000/$0.000/$0.250/$0.325/$0.374/$0.404 a. $8.60 b. $9.29 c. $9.21 d. $10.75 e. $10.50

Dividend for year 3=$0.25 Dividend for year 4=$0.325 Dividend for year 5=$0.374 Value after 5 years=(Dividend for year 5*Growth rate)/(required rate-growth rate) =(0.374*1.08)/(0.11-0.08) =$13.464 Hence current price=future dividends*Present value of discount factor(11%,time period) =0.25/1.11^3+0.325/1.11^4+0.374/1.11^5+13.464/1.11^5 =$8.60 Therefore answer = A

Which of the following statements is CORRECT? a. The corporate valuation model requires the assumption of a constant growth rate in all years. b. To implement the corporate valuation model, we discount projected net income at the weighted average cost of capital. c. To implement the corporate valuation model, we discount net operating profit after taxes (NOPAT) at the weighted average cost of capital. d. To implement the corporate valuation model, we discount projected free cash flows at the cost of equity capital. e. To implement the corporate valuation model, we discount projected free cash flows at the weighted average cost of capital.

E.

Holtzman Clothiers's stock currently sells for $19 a share. It just paid a dividend of $3.5 a share (i.e., D0 = $3.5). The dividend is expected to grow at a constant rate of 7% a year. What stock price is expected 1 year from now? Round your answer to two decimal places.$ What is the required rate of return? Round your answer to two decimal places. Do not round your intermediate calculations. %

The Stock price is expected 1 year from now The Stock price is expected 1 year from now = Current Share Price x (1 + growth Rate) = $19.00 per share x (1 + 0.07) = $19.00 x 1.07 = $20.33 per share Required rate of return on the stock Using Constant Growth Dividend Valuation Model, the Required Rate of Return is calculated as follows Required Rate of Return = [D0(1 + g) / P0] + g Here, we've Last Year Dividend (D0) = $3.50 per share Current Share Price (P0) = $19.00 per share Dividend Growth Rate (g) = 7.00% per year Therefore, the Required Rate of Return = [D0(1 + g) / P0] + g = [$3.50(1 + 0.07) / $19.00] + 0.07 = [$3.745 / $19.00] + 0.07 = 0.1971 + 0.07 = 0.2671 or = 26.71% "Hence, the Required Rate of Return on the stock would be 26.71%"

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 8% rate. Dantzler's WACC is 10%. Year0123...............................................................................................................FCF ($ millions)- $18$29$59 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 $13,550,000 should be entered as 13.55.$ million What is the firm's value today? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $13,550,000 should be entered as 13.55. Do not round your intermediate calculations.$ million Suppose Dantzler has $34 million of debt and 13 million shares of stock outstanding. What is your estimate of the current price per share? Round your answer to two decimal places. Write out your answer completely. For example, 0.00025 million should be entered as 250.$

a. Horizon Value = 59(1.08)/(0.10 - 0.08) Horizon Value = $3186 million b. Firm Value = -18/(1.10) + 29/(1.10)^2 + (3186+ 59)/(1.10)^3 Firm Value = $2445.62million c. Price per Share = (2445.62 - 34)/13 Price per Share = $185.51

Firms can use different classes of common stock to meet specific needs of the company. Founders' shares are one such class. They are shares owned by the firm's founders that enable them to maintain control over the company without having to own a majority of stock. True or false? a. True b. False

a. True

Preferred stock is a "hybrid" security. Preferreds typically pay a fixed dividend, so they are a fixed-income security like a bond. However, the directors can omit the preferred dividend without throwing the company into bankruptcy. True or false? a. True b. False

a. True

Proxy fights are attempts by a person or group that wants to take over control of a firm by getting the firms' stockholders to give their voting proxies to the new group. True or false? a. True b. False

a. True

The preemptive right is the right of current stockholders to buy new shares in an amount that will maintain their proportionate ownership in the firm. True or false? a. True b. False

a. True

The value of a share of common stock depends on the cash flows it is expected to provide, and those flows consist of two elements: (1) the dividends the investor receives each year while he or she holds the stock and (2) the price received when the stock is sold. The final price includes the original price paid plus an expected capital gain. True or false? a. True b. False

a. True

The value of a share of stock can be estimated by using the PV of future dividends. An alternative valuation procedure, called the "corporate valuation model," calls for finding the expected future free cash flows, discounting those cash flows at the weighted average cost of capital, summing the PVs of the free cash flows, subtracting the market values of debt and preferred to calculate the value of the common equity, and then dividing by the number of shares outstanding to find the value of a share of common stock. In theory, the two methods should produce the same stock price. Is this statement true or false? a. True b. False

a. True

To estimate the value of a nonconstant growth stock, we can estimate the value of each dividend during the period of nonconstant growth, find the PVs of these dividends, find the value of the stock at the horizon date, find the PV of the horizon value, and then sum these PVs to find the value of the stock today. True or false? a. True b. False

a. True

Holt Enterprises recently paid a dividend, D0, of $3.50. It expects to have nonconstant growth of 15% for 2 years followed by a constant rate of 8% thereafter. The firm's required return is 20%. How far away is the horizon date? 1. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2. 2. The terminal, or horizon, date is infinity since common stocks do not have a maturity date. 3. The terminal, or horizon, date is Year 0 since the value of a common stock is the present value of all future expected dividends at time zero. 4. The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero. 5. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2. b. What is the firm's horizon, or continuing, value? Round your answer to two decimal places. Do not round your intermediate calculations.$ c. What is the firm's intrinsic value today, P̂0? Round your answer to two decimal places. Do not round your intermediate calculations.

a. a. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2. b. P= 3.50x (1.15^2) x 1.08/ 0.20-.08 = 4.99905/0.12= $41.66 c. P= 3.50x 1.15/1.20 =3.35 + 3.50 x 1.15 ^2/1.20^2 =3.21 +41.66/1.20^2 =28.93 3.35 + 3.21 + 28.93 = $35.49

If a firm goes bankrupt and must be liquidated, and if less money is available than the balance sheet values of bonds, preferred stock, and common equity, then some security holders will receive less than the book values of their investments. The priority system under our bankruptcy laws allocates funds first to preferred stock because of its preference, then to bonds, and then to common stockholders (only if there are funds left over after paying preferred stockholders and bondholders). True or false? a. True b. False

b. False The priority system under bankruptcy laws allocates funds is as follows First --- to secured creditor (secured creditors gave loans based on the property of the company.) Second -- Unsecured Creditors (these debts are not based on the property of the company. These are like unpaid credit card bill, bank loan, unpaid premium. It also includes bonds.) Third --- Shareholders (If any money left with the company then shareholders will be paid. Shareholders include Preferred Shareholders and Common Shareholders). Hence the sequence/priority given in the above statement is First ---Preferred Stock, then (Second -- bonds) and then (third) to common stockholders ----- It is incorrect. Correct sequence under bankruptcy law is First the funds to be paid to SECURED CREDITORS Next (Second) --- UNSECUReD CReDitoR (which includes Bonds Next (Third) --- Shareholders (Preferred and Common)..

Farley Inc. has perpetual preferred stock outstanding that sells for $46.00 a share and pays a dividend of $5.00 at the end of each year. What is the required rate of return? Round your answer to two decimal places. %

required rate of return=annual dividend/current price which is equal to =(5/46) which is equal to =10.87%(Approx).