int finc mgmt final
Suppose you own 2,000 common shares of Laurence Incorporated. The EPS is $10.00, the DPS is $3.00, and the stock sells for $80 per share. Laurence announces a 2-for-1 split. Immediately after the split, how many shares will you have, what will the adjusted EPS and DPS be, and what would you expect the stock price to be?
Number of shares = 2,000(2) = 4,000. EPS = $10.00/2 = $5.00. DPS = $3.00/2 = $1.50. Price = $40.00.
The real risk-free rate of interest is 4%. Inflation is expected to be 2% this year and 4% during each of the next 2 years. Assume that the maturity risk premium is zero. 1) What is the yield on 2-year Treasury securities? 2) What is the yield on 3-year Treasury securities?
1) (2%+4%)/2 = 3% 4%+3% = 7% 2) (2%+4%+4%)/3 = 3.33% 4%+3.33% = 7.33%
Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $17 million, and production and sales will require an initial $5 million investment in net operating working capital. The company's tax rate is 40%. 1) What is the initial investment outlay? 2)The company spent and expensed $150,000 on research related to the new product last year. Would this change your answer? Explain. 3)Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. How would this affect your answer?
1) Equipment $ 17,000,000 NWC Investment 5,000,000 Initial investment outlay $22,000,000 2)No, last year's $150,000 expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. 3)The potential sale of the building represents an opportunity cost of conducting the project in that building. Therefore, the possible after-tax sale price must be charged against the project as a cost
Thatcher Corporation's bonds will mature in 10 years. The bonds have a face value of $1,000 and an 8% coupon rate, paid semiannually. The price of the bonds is $1,100. The bonds are callable in 5 years at a call price of $1,050. 1)What is their yield to maturity? 2)What is their yield to call?
1) N = 10*2 = 20; PV = -1100; PMT = 0.08/2 * 1,000 = 40; FV = 1000; I/YR = YTM = ? YTM = 3.31% *2 = 6.62%. 2) N = 5*2 = 10; PV = -1100; PMT = 0.08/2 *1,000 = 40; FV = 1050; I/YR = YTC = ? YTC = 3.24%*2 = 6.49%.
Your division is considering two investment projects, each of which requires an up-front expenditure of $15 million. You estimate that the investments will produce the following net cash flows: Year Project A Project B 1 5,000,000 20,000,000 2 10,000,000 10,000,000 3 20,000,000 6,000,000 1)What are the two projects' net present values, assuming the cost of capital is 5%? 10%? 15%? 2)What are the two projects' net present values, assuming the cost of capital is 5%? 10%? 15%?
1) Project A: Using a financial calculator, enter the following: CF0 = -15000000 CF1 = 5000000 CF2 = 10000000 CF3 = 20000000 I/YR = 10; NPV = $12,836,213. Change I/YR = 10 to I/YR = 5; NPV = $16,108,952. Change I/YR = 5 to I/YR = 15; NPV = $10,059,587. Project B: Using a financial calculator, enter the following: CF0 = -15000000 CF1 = 20000000 CF2 = 10000000 CF3 = 6000000 I/YR = 10; NPV = $15,954,170. Change I/YR = 10 to I/YR = 5; NPV = $18,300,939. Change I/YR = 5 to I/YR = 15; NPV = $13,897,838. 2)Using the data for Project A, enter the cash flows into a financial calculator and solve for IRRA = 43.97%. The IRR is independent of the WACC, so IRR doesn't change when the WACC changes. Using the data for Project B, enter the cash flows into a financial calculator and solve for IRRB = 82.03%. Again, the IRR is independent of the WACC, so IRR doesn't change when the WACC changes.
The market and Stock J have the following probability distributions: Probability rM rJ 0.3 15% 20% 0.4 9 5 0.3 18 12 1)Calculate the expected rates of return for the market and Stock J 2)Calculate the standard deviations for the market and Stock J
1) rM = (0.3)(15%) + (0.4)(9%) + (0.3)(18%) = 13.5%. rJ = (0.3)(20%) + (0.4)(5%) + (0.3)(12%) = 11.6%. 2) oM = [(0.3)(15% - 13.5%)^2 + (0.4)(9% - 13.5%)^2 + (0.3)(18% -13.5%)^2]^1/2 = 14.85 -- sqr root of 14.85 = 3.85% oJ = [(0.3)(20% - 11.6%)^2 + (0.4)(5% - 11.6%)^2 + (0.3)(12% - 11.6%)^2]^1/2 = 38.64 -- sqr root = 6.22
Present and Future Values of Single Cash Flows for Different Periods 1) An initial $500 compounded for 1 year at 6% 2) An initial $500 compounded for 2 years at 6% 3) The present value of $500 due in 1 year at a discount rate of 6% 4) The present value of $500 due in 2 years at a discount rate of 6%
1) 500(1.06) = 530 2)500(1.06)^2 = 561 3)500(1/1.06) = 471 4)500(1/1.06)^2 = 445
Suppose rRF = 5%, rM = 10%, and rA = 12% 1)Calculate stock A's beta 2)If stock A's beta were 2.0, then what would be A's new required rate of return?
1) rA = rRF + (rM-rRF)bA 12% = 5% + (10%-5%)bA bA = 1.4 2)rA = 5% +5%(bA) =5+5(2) = 15%
Calculate the after-tax cost of debt under each of the following conditions: 1)rd of 13%, tax rate of 0% 2)rd of 13%, tax rate of 20% 3)rd of 13%, tax rate of 35%
1) rd(1-T)= 13%(1-0) = 13% 2)13%(1-0.20) = 10.40% 3)13%(1-0.35) = 8.45%
Future Value: Ordinary Annuity versus Annuity Due What is the future value of a 7%, 5-year ordinary annuity that pays $300 each year? If this were an annuity due, what would its future value be?
N = 5, I/YR = 7, PV = 0, and PMT = 300. Solve for FV = $1,725.22. With a financial calculator, switch to "BEG" and enter the following: N = 5, I/YR = 7, PV = 0, and PMT = 300. Solve for FV = $1,845.99.
The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 7% per year in the future. Shelby's common stock sells for $23 per share, its last dividend was $2.00, and the company will pay a dividend of $2.14 at the end of the current year. 1)Using the discounted cash flow approach, what is its cost of equity? 2)If the firm's beta is 1.6, the risk-free rate is 9%, and the expected return on the market is 13%, then what would be the firm's cost of equity based on the CAPM approach? 3)If the firm's bonds earn a return of 12%, then what would be your estimate of rs using the own-bond-yield-plus-judgmental-risk-premium approach? 4)On the basis of the results of parts 1-3, what would be your estimate of Shelby's cost of equity?
1) rs= D1/P0 + g = 2.14/23 +7% = 16.3% 2)rs= rRF + (rM-rRF)b =9% + (13%-9%)1.6 = 15.4% 3)rs= bond rate + risk premium =12% + 4% = 16% 4)The bond-yield-plus-judgmental-risk-premium approach and the CAPM method both resulted in lower cost of equity values than the dividend growth approach. The firm's cost of equity should be estimated to be about 15.9%, which is the average of the three methods
Present and Future Values of Single Cash Flows for Different Interest Rates 1) An initial $500 compounded for 10 years at 6% 2) An initial $500 compounded for 10 years at 12% 3) The present value of $500 due in 10 years at a 6% discount rate 4) The present value of $500 due in 10 years at a 12% discount rate
1)500(1.06)^10 = 895 2)500(1.12)^10 = 1,552 3)500(1/1.06)^10 = 279 4)500(1/1.12)^10 = 160
Broussard Skateboard's sales are expected to increase by 15% from $8 million in 2018 to $9.2 million in 2019. Its assets totaled $5 million at the end of 2018. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2018, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 6%, and the forecasted payout ratio is 40%. 1)Use the AFN equation to forecast Broussard's additional funds needed for the coming year. 2)What would be the additional funds needed if the company's year-end 2018 assets had been $7 million? 3)but now assume that the company pays no dividends. Under these assumptions, what would be the additional funds needed for the coming year?
1)AFN = (A0*/S0)∆S - (L0*/S0)∆S - (PM)(S1)(1 - payout rate) = (5,000,000/8,000,000)$1,200,000 - (900,000/8,000,000)$1,200,000 - 0.06($9,200,000)(1 - 0.4) = (0.625)($1,200,000) - (0.1125)($1,200,000) - ($552,000)(0.6) = $750,000 - $135,000 - $331,200 = $283,800. 2)AFN= (7,000,000/8,000,000)$1,200,000 - (900,000/8,000,000)$1,200,000 - 0.06($9,200,000)(1 - 0.4) =(0.875)($1,200,000) - $135,000 - $331,200 = $1,050,000 - $466,200 = $583,800. 3)AFN = (0.625)($1,200,000) - (0.1125)($1,200,000) - 0.06($9,200,000)(1 - 0) = $750,000 - $135,000 - $552,000 = $63,000. Under this scenario the company would have a higher level of retained earnings which would reduce the amount of additional funds needed.
A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of 11%. 1)What is the project's NPV? 2)What is the project's IRR? 3)What is the project's MIRR? 4)What is the project's PI(Profitability index)? 5)What is the project's payback period? 6)What is the project's discounted payback period?
1)NPV = -$40,000 + $9,000[(1/I) - (1/(I × (1 + I)^N)] = -$40,000 + $9,000[(1/0.11) - (1/(0.11 × (1 + 0.11)^7)] = $2,409.77. 2)Financial calculator solution: Input CF0 = -40000, CF1-8 = 9000, and then solve for IRR = 12.84%. 3) 4)PV = $9,000[(1/I) - (1/(I × (1 + I)^N)] = $9,000[(1/0.11) - (1/(0.11 × (1 + 0.11)^7)] = $42,410. PI = PV of future cash flows/Initial cost = $42,409/$40,000 = 1.06. 5)Since the cash flows are a constant $9,000, calculate the payback period as: $40,000/$9,000 = 4.44, so the payback is about 4 years. 6)The project's discounted payback period is calculated as follows: Year Annual CF DiscountCF@11% Discounted CF 0 -40,000 -40,000 1 9,000 8,108 (31,892) 2 9,000 7,305 (24,587) 3 9,000 6,580 (18,007) 4 9,000 5,928 (12,007) 5 6 7 The discounted payback period is 6 + 1,925/4,334 years, or 6.44 years.
Your investment club has only two stocks in its portfolio. $20,000 is invested in a stock with a beta of 0.7, and $35,000 is invested in a stock with a beta of 1.3. What is the portfolio's beta?
20,000+35,000 = 55,000 (20,000/55,000)(0.7) + (35,000/55,000)(1.3) = 1.08
The current price of a stock is $33, and the annual risk-free rate is 6%. A call option with a strike price of $32 and with 1 year until expiration has a current value of $6.56. What is the value of a put option written on the stock with the same exercise price and expiration date as the call option?
= $6.56 - $33 + $32e^(-0.06*1) = $6.56 - $33 + $30.136 = $3.696 » $3.70.
Nick's Enchiladas has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock's required rate of return (assume the market is in equilibrium with the required return equal to the expected return)?
Dps= $5 Vps=$50 rps=? rps= Dps/Vps =5/50 = 10%
Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $110,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $19,000 per year. It would have zero salvage value at the end of its life. The project cost of capital is 10%, and its marginal tax rate is 35%. Should Chen buy the new machine?
Cash outflow = $110,000. Increase in annual after-tax cash flows: CF = $19,000. With a financial calculator, input the appropriate cash flows into the cash flow register, input I/YR = 10, and then solve for NPV = $6,746.78. Thus, Chen should purchase the new machine.
Thress Industries just paid a dividend of $1.50 a share (D0=$1.50). The dividend is expected to grow 5% a year for the next 3 years and then 10% a year thereafter. What is the expected dividend per share for each of the next 5 years?
D0=$1.50 g1-3=5% gn=10% D1-D5? D1=D0(1+g1) = $1.50(1.05) = $1.5750 D2=D0(1+g1)(1+g2)= $1.50(1.05)^2= $1.65 D3=D0(1+g1)(1+g2)(1+g3)= $1.50(1.05)^3= $1.7 D4=D0(1+g1)(1+g2)(1+g3)(1+gn)= $1.50(1.05)^3 (1.10)= $1.9 D5=D0(1+g1)(1+g2)(1+g3)(1+gn)^2= $1.50(1.05)^3(1.10)^2=
Boehm Incorporated is expected to pay a $1.50 per share dividend at the end of this year (D1=$1.50). The dividend is expected to grow at a constant rate of 6% a year. The required rate of return on the stock, rs, is 13%. What is the estimated value per share of Boehm's stock?
D1= $1.50 g=6% rs=13% P0=? P0= D1/(rs-g) = $1.50/(0.13-0.06) = $21.43
A company's 6% coupon rate, semiannual payment, $1,000 par value bond that matures in 30 years sells at a price of $515.16. The company's federal-plus-state tax rate is 40%. What is the firm's after-tax component cost of debt for purposes of calculating the WACC?
Enter these values: N = 60, PV = -515.16, PMT = 30, and FV = 1000, to get I = 6% = periodic rate. The nominal rate is 6%(2) = 12%, and the after-tax component cost of debt is 12%(0.6) = 7.2%.
Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $12 million, of which 75% has been depreciated. The used equipment can be sold today for $4 million, and its tax rate is 40%. What is the equipment's after-tax net salvage value?
Equipment's original cost $12,000,000 Depreciation (80%) 9,000,000 Book value $ 3,000,000 Gain on sale = $4,000,000 - $3,000,000 = $1,000,000. Tax on gain = $1,000,000(0.4) = $400,000. AT net salvage value = $4,000,000 - $400,000 = $3,600,000.
The Wei Corporation expects next year's net income to be $15 million. The firm is currently financed with 40% debt. Wei has $12 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual distribution model (assuming all payments are in the form of dividends), how large should Wei's dividend payout ratio be next year?
Equity financing = $12,000,000(0.60) = $7,200,000. Dividends = Net income - Equity financing = $15,000,000 - $7,200,000 = $7,800,000. Dividend payout ratio = Dividends/Net income = $7,800,000/$15,000,000 = 52%.
A call option on the stock of Bedrock Boulders has a market price of $7. The stock sells for $30 a share, and the option has a strike price of $25 a share. What is the exercise value of the call option? What is the option's time value?
Exercise value = Current stock price - strike price = $30 - $25 = $5. Time value = Option price - Exercise value = $7 - $5 = $2.
Number of Periods for an Annuity You have $42,180.53 in a brokerage account, and you plan to deposit an additional $5,000 at the end of every future year until your account totals $250,000. You expect to earn 12% annually on the account. How many years will it take to reach your goal?
I/YR = 12; PV = -42180.53; PMT = -5000; FV = 250000; N = ? Solve for N = 11. It will take 11 years to accumulate $250,000.
Number of Periods of a Single Payment If you deposit money today in an account that pays 6.5% annual interest, how long will it take to double your money?
I/YR = 6.5, PV = -1, PMT = 0, and FV = 2. Solve for N = 11.01 ≈ 11 years
Ethier Enterprise has an unlevered beta of 1.0. Ethier is financed with 50% debt and has a levered beta of 1.6. If the risk-free rate is 5.5% and the market risk premium is 6%, how much is the additional premium that Ethier's shareholders require to be compensated for financial risk?
If the company had no debt, its required return would be: rS,U= rRF+bU*rPM = 5.5+1.0(6) = 11.5% With debt, the required return is: rS,L = rRF+bL*rPM = 5.5+1.6(6) = 15.1% so additional premium = 15.1-11.5 = 3.6%
Counts Accounting's beta is 1.15 and its tax rate is 40%. If it is financed with 20% debt, what is its unlevered beta?
If wd=0.2, then wce = 1-0.2 = 0.8 So D/S = wd/we = 0.2/0.8 bU = b/[1+(1-T)(D/S)] =1.15/[1+(1-0.40)(0.2/0.8)] = 1.0
Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity of 8.5%. What is the price of the bonds?
N = 16; I/YR = 8.5/2 = 4.25; PMT = 50; FV = 1000. With a financial calculator, solve for PV = $1,085.80
Interest Rate on a Single Payment Your parents will retire in 18 years. They currently have $250,000, and they think they will need $1 million at retirement. What annual interest rate must they earn to reach their goal, assuming they don't save any additional funds?
N = 18, PV = -250000, PMT = 0, and FV = 1000000. Solve for I/YR = 8.01% ≈ 8%
Present Value of a Single Payment What is the present value of a security that will pay $5,000 in 20 years if securities of equal risk pay 7% annually?
N = 20, I/YR = 7, PMT = 0, and FV = 5000. Solve for PV = $1,292.10
1Future Value of a Single Payment If you deposit $10,000 in a bank account that pays 10% interest annually, how much will be in your account after 5 years?
N = 5, I/YR = 10, PV = - 10000, and PMT = 0. Solve for FV = $16,105.10
Heath Food Corporation's bonds have 7 years remaining to maturity. The bonds have a face value of $1,000 and a yield to maturity of 8%. They pay interest annually and have a 9% coupon rate. What is their current yield?
N = 7; I/YR = YTM = 8; PMT = 0.09* 1,000 = 90; FV = 1000; PV = VB = ? PV = $1,052.06. Current yield = $90/$1,052.06 = 8.55%.
Dye Trucking raised $150 million in new debt and used this to buy back stock. After the recap, Dye's stock price is $7.50. If Dye had 60 million shares of stock before the recap, how many shares does it have after the recap?
Npost= original shares - shares repurchased =Nprior-(dollar value of shares repurchased/repurchase price) =60-($150/$7.50) = 40 million
The financial staff of Cairn Communications has identified the following information for the first year of the roll-out of its new proposed service: Projected sales $18 million Operating costs (not including depreciation)$ 9 million Depreciation $ 4 million Interest expense $ 3 million The company faces a 40% tax rate. What is the project's cash flow for the first year? (t=1)
Operating Cash Flows: t = 1 Sales revenues $18,000,000 Operating costs 9,000,000 Depreciation 4,000,000 Operating income before taxes $ 5,000,000 Taxes (40%) (5M*40%) 2,000,000 Operating income after taxes $ 3,000,000 Add back depreciation 4,000,000 Operating cash flow $ 7,000,000
The exercise price on one of Flanagan Company's call options is $15, its exercise value is $22, and its time value is $5. What are the option's market value and the price of the stock?
Option's strike price = $15; Exercise value = $22; Time value = $5; V = ? P0 = ? Time Value = Market price of option - Exercise value $5 = V - $22 V = $27. Exercise value = P0 - Strike price $22 = P0 - $15 P0 = $37.
Assume that you have been given the following information on Purcell Industries call options: Current stock price= $15 Strike price= $15 Time to maturity of option= 6 months Risk-free rate=6% Variance of stock return= 0.12 N(d1)= 0.59675 d1= 0.24495 d2=0.0000 N(d2)= 0.50000 According to the Black-Scholes option pricing model, what is the option's value?
P = $15; X = $15; t = 0.5; rRF = 0.06; o^2 = 0.12; d1=0.24495; d2 = 0.0000; N(d1) = 0.59675; N(d2) = 0.500000; V = ? = $15(0.59675) - $15e^(-0.06*0.5) (0.50000) = $8.95128 - $15(0.9512)(0.50000) = $1.6729 » $1.67.
Woidtke Manufacturing's stock currently sells for $22 a share. The stock just paid a dividend of $1.20 a share (D0=$1.20), and the dividend is expected to grow forever at a constant rate of 10% a year. What stock price is expected 1 year from now? What is the estimated required rate of return on Woidtke's stock (assume the market is in equilibrium with the required return equal to the expected return)?
P0 = $22; D0 = $1.20; g = 10% P1= ?; rs= ? P1= P0(1 + g) = $22(1.10) = $24.20. rs =D1/P0 + g = $1.20(1.10)/$22 + 0.10 =$1.32/$22 +0.10 = 16% so, rs= 16%
JPix management is considering a stock split. JPix currently sells for $120 per share and a 3-for-2 stock split is contemplated. What will be the company's stock price following the stock split, assuming that the split has no effect on the total market value of JPix's equity?
P0=120, Split = 3 for 2, New P0? P0new= 120/(3/2) = $80
An analyst has modeled the stock of a company using the Fama-French three-factor model. The market return is 10%, the return on the SMB portfolio (rSMB) is 3.2%, and the return on the HML portfolio (rHML) is 4.8%. If ai = 0, bi = 1.2, ci = -0.4, and di = 1.3, what is the stock's predicted return?
Predicted return = ai+bi(rMt) +ci(rSMBt)+di(rHMLt) =0.0+1.2(10%)+(-0.4)(3.2%)+1.3(4.8%) =16.96%
Gardial GreenLights, a manufacturer of energy-efficient lighting solutions, has had such success with its new products that it is planning to substantially expand its manufacturing capacity with a $15 million investment in new machinery. Gardial plans to maintain its current 30% debt-to-total-assets ratio for its capital structure and to maintain its dividend policy in which at the end of each year it distributes 55% of the year's net income. This year's net income was $8 million. How much external equity must Gardial seek now to expand as planned?
Retained earnings = Net income (1 - Payout ratio) = $8,000,000(0.45) = $3,600,000. External equity needed: Total equity required = (New investment)(1 - Debt ratio) = $15,000,000(0.70) = $10,500,000. New external equity needed = $10,500,000 - $3,600,000 = $6,900,000.
Maggie's Muffins Bakery generated $5 million in sales during 2018, and its year-end total assets were $2.5 million. Also, at year-end 2018, current liabilities were $1 million, consisting of $300,000 of notes payable, $500,000 of accounts payable, and $200,000 of accruals. Looking ahead to 2019, the company estimates that its assets must increase at the same rate as sales, its spontaneous liabilities will increase at the same rate as sales, its profit margin will be 7%, and its payout ratio will be 80%. How large a sales increase can the company achieve without having to raise funds externally—that is, what is its self-supporting growth rate?
S0=$5,000,000 A0= $2,500,000 CL = $700,000; NP = $300,000; AP = $500,000; Accruals = $200,000; M = 7%; payout ratio = 80% A0/S0= 0.50 L0=(AP+Accruals)/S0 = ($500,000 + $200,000)/$5,000,000 = 0.14. AFN= (0.50)∆S - (0.14) ∆S - (0.07)(S1)(1 - 0.8) = (0.50)∆S - (0.14)∆S - (0.014)S1 = (0.36)∆S - (0.014)S1 = 0.36(S1 - S0) - (0.014)S1 = 0.36(S1 - $5,000,000) - (0.014)S1 = 0.36S1 - $1,800,000 - 0.014S1 $1,800,000 = 0.346S1 $5,202,312 = S1. Sales can increase by $5,202,312 - $5,000,000 = $202,312 without additional funds being needed.
Nichols Corporation's value of operations is equal to $500 million after a recapitalization (the firm had no debt before the recap). It raised $200 million in new debt and used this to buy back stock. Nichols had no short-term investments before or after the recap. After the recap, wd = 40% . What is S (the value of equity after the recap)?
Spost= (1-wd)(VOPNEW) = (1-0.4)(500)= $300 million
Lee Manufacturing's value of operations is equal to $900 million after a recapitalization. (The firm had no debt before the recap.) Lee raised $300 million in new debt and used this to buy back stock. Lee had no short-term investments before or after the recap. After the recap, wd=1/3. The firm had 30 million shares before the recap. What is P (the stock price after the recap)?
Spost= (1-wd)(VOPNEW) = (1-1/3)(900) = $600 million Ppost= (VOPNEW-Dold)/Nprior= (900-0)/30= $30
company currently pays a dividend of $2 per share (D0=$2) . It is estimated that the company's dividend will grow at a rate of 20% per year for the next 2 years and then at a constant rate of 7% thereafter. The company's stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock's current price?
Step 1: Calculate the required rate of return on the stock: rs= rRF + (rM-rRF)b = 7.5%+(4%)1.2 = 12.3% Step 2: Calculate the expected dividends: D0 = $2.00 D1 = $2.00(1.20) = $2.40 D2 = $2.00(1.20)^2 = $2.88 D3 = $2.88(1.07) = $3.08 Step 3: Calculate the PV of the expected dividends: PVDiv = $2.40/(1.123) + $2.88/(1.123)2 = $2.14 + $2.28 = $4.42. Calculate P2: P2= D3/(rs - g) = $3.08/(0.123 - 0.07) = $58.11. Step 5: Calculate the PV of P2 : PV = $58.11/(1.123)^2 = $46.08. Step 6: Sum the PVs to obtain the stock's price: = $4.42 + $46.08 = $50.50.
Petersen Company has a capital budget of $1.2 million. The company wants to maintain a target capital structure that is 60% debt and 40% equity. The company forecasts that its net income this year will be $600,000. If the company follows a residual distribution model and pays all distributions as dividends, what will be its payout ratio?
The company requires 0.40($1,200,000) = $480,000 of equity financing. If the company follows a residual dividend policy it will retain $480,000 for its capital budget and pay out the $120,000 "residual" to its shareholders as a dividend. The payout ratio would therefore be $120,000/$600,000 = 0.20 = 20%.
Current and projected free cash flows for Radell Global Operations are shown here. Growth is expected to be constant after 2020, and the weighted average cost of capital is 11%. What is the horizon (continuing) value at 2021 if growth from 2020 remains constant? Actual Projected 2018 2019 2020 2021 Free cash flow(millions) $606.82 $667.50 $707.55 $750
The growth rate in FCF from 2020 to 2021 is g = ($750.00-$707.55)/$707.50 = 0.06. HV2021 = Vop at 2021 =$707.55(1.06) / (0.11-0.06) = $15,000
Present and Future Value of an Uneven Cash Flow Stream An investment will pay $100 at the end of each of the next 3 years, $200 at the end of Year 4, $300 at the end of Year 5, and $500 at the end of Year 6. If other investments of equal risk earn 8% annually, what is this investment's present value? Its future value?
Using a financial calculator, enter the following: CF0 = 0; CF1 = 100; Nj = 3; CF4 = 200 (Note calculator will show CF2 on screen.); CF5 = 300 (Note calculator will show CF3 on screen.); CF6 = 500 (Note calculator will show CF4 on screen.); and I/YR = 8. Solve for NPV = $923.98. To solve for the FV of the cash flow stream with a calculator that doesn't have the NFV key, do the following: Enter N = 6, I/YR = 8, PV = -923.98, and PMT = 0. Solve for FV = $1,466.24.
Annuity Payment and EAR You want to buy a car, and a local bank will lend you $20,000. The loan would be fully amortized over 5 years (60 months), and the nominal interest rate would be 12%, with interest paid monthly. What is the monthly loan payment? What is the loan's EFF%?
Using a financial calculator, enter the following: N = 60, I/YR = 1, PV = -20000, and FV = 0. Solve for PMT = $444.89. EAR = (1+I/M)^M) - 1.0 =(1.01)^12 - 1.0 = 12.68%
A firm has 10 million shares outstanding with a market price of $20 per share. The firm has $25 million in extra cash (short-term investments) that it plans to use in a stock repurchase; the firm has no other financial investments or any debt. What is the firm's value of operations, and how many shares will remain after the repurchase?
VOP= (n0P)-Extra cash= (10,000,000 x $20) − $25,000,000 = $175,000,000. n= VOP/P = 175,000,000/20 = 8,750,000
EMC Corporation has never paid a dividend. Its current free cash flow of $400,000 is expected to grow at a constant rate of 5%. The weighted average cost of capital is . Calculate EMC's estimated value of operations.
Value of operations = Vop = PV of expected future free cash flow Vop= [FCF(1+g)]/[WACC -g] =$400,000(1.05) / 0.12-0.05 = $6,000,000
Shi Import-Export's balance sheet shows $300 million in debt, $50 million in preferred stock, and $250 million in total common equity. Shi's tax rate is 40%, rd=6%, rps=5.8%, and rs=12%. If Shi has a target capital structure of 30% debt, 5% preferred stock, and 65% common stock, what is its WACC?
WACC= (wd)(rd)(1-T) + (wps)(rps) + (ws)(rs) =0.30(0.06)(1-0.40) + 0.05(0.058) + 0.65(0.12) = 9.17%
Jackson Corporation's bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 9%. What is the current market price of these bonds?
With your financial calculator, enter the following: N = 12; I/YR = YTM = 9%; PMT = 0.08* 1,000 = 80; FV = 1000; PV = VB = ? PV = $928.39.
Wilson Corporation's bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 10%. The bonds sell at a price of $850. What is their yield to maturity?
With your financial calculator, enter the following: N = 12; PV = -850; PMT = 0.10* 1,000 = 100; FV = 1000; I/YR = YTM = ? YTM = 12.48%.
A stock's return has the following distribution: Calculate the stock's expected return and standard deviation
^ r=(0.1)(-50%) + (0.2)(-5%) + (0.4)(16%) +(0.2)(25%) + (0.1)(60%) = 11.40% o2 = (-50-11.40)^2(0.1) + (-5-11.40)^2(0.2).... o2=0.0712 o=0.2669 = 26.69%
Puckett Products is planning for $5 million in capital expenditures next year. Puckett's target capital structure consists of 60% debt and 40% equity. If net income next year is $3 million and Puckett follows a residual distribution policy with all distributions as dividends, what will be its dividend payout ratio?
equity retained for capital budget= 0.4($5,000,000)= $2,000,000 NI 3,000,000 (Additions) (2,000,000) Earnings Remaining 1,000,000 Payout= 1,000,000/3,000,000 = 33.33%
Shapland Inc. has fixed operating costs of $500,000 and variable costs of $50 per unit. If it sells the product for $75 per unit, what is the break-even quantity?
qBE=F/(P-V) =500,000/(75-50) = 20,000
Duggins Veterinary Supplies can issue perpetual preferred stock at a price of $50 a share with an annual dividend of $4.50 a share. Ignoring flotation costs, what is the company's cost of preferred stock, rPS?
rPS= Dps/Vps (1-F) =4.50/50(1-0.0) = 9%
AA Corporation's stock has a beta of 0.8. The risk-free rate is 4%, and the expected return on the market is 12%. What is the required rate of return on AA's stock?
rRF=4%, rM=12%, b=0.8, rS? rS = rRF+(rM-rRF)b =4%+(12%-4%)0.8 =10.4%
Suppose that the risk-free rate is 5% and that the market risk premium is 7%. What is the required return on (a) the market, (b) a stock with a beta of 1.0, and (c) a stock with a beta of 1.7?
rRF=5%, RPm=7%, rM =? (a)(b): rM=5%+(7%)1= 12% =rS when b = 1.0 (c): rS when b =1.7? rS= 5%+7%(1.7) = 16.9%
LL Incorporated's currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL's after-tax cost of debt?
rd(1-T) = 0.08(1-0.35) = 5.2%
Burnwood Tech plans to issue some $60 par preferred stock with a 6% dividend. A similar stock is selling on the market for $70. Burnwood must pay flotation costs of 5% of the issue price. What is the cost of the preferred stock?
rps= 60(0.06)/70(1-0.05) =3.60/66.50 = 5.41%
Summerdahl Resort's common stock is currently trading at $36 a share. The stock is expected to pay a dividend of $3.00 a share at the end of the year (D1=$3.00), and the dividend is expected to grow at a constant rate of 5% a year. What is its cost of common equity?
rs= D1/P0 + g = (3/36)+ 0.05 = 13.33%
Booher Book Stores has a beta of 0.8. The yield on a 3-month T-bill is 4%, and the yield on a 10-year T-bond is 6%. The market risk premium is 5.5%, and the return on an average stock in the market last year was 15%. What is the estimated cost of common equity using the CAPM?
rs= rRF + b(RPm) = 0.06 +0.8(0.055) = 10.4%
David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company's outstanding bonds is 9%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 9.96%. What is the company's cost of equity capital?
use WACC formula(from question above) 9.96% = (0.4)(9%)(1-0.4) + (0.6)rs 9.96 = 2.16 + 0.6rs rs= 13%