FIN CHAPTER 08 SOL complete

8-1

DPS CALCULATION        WARR CORPORATION just paid a dividend of $1.50 a share (i.e., D0=$1.50).  The dividend is expected to grow 5 percent a year for the next 3 years, and then 10 percent a year thereafter.  

WHAT IS THE EXPECTED DIVIDEND PER SHARE FOR EACH OF THE NEXT 5 YEARS?

8-2

CONSTANT GROWTH VALUATION        THOMAS BROTHERS is expected to pay a $0.50 per share dividend at the end of the year (i.e., D1=$0.50).  The dividend is expected to grow at a constant rate of 7 percent a year.  The required rate of return on the stock, ks, is 15 percent.  

WHAT IS THE VALUE PER SHARE OF THE COMPANY’S STOCK?
        

8-3

CONSTANT GROWTH VALUATION        HARRISON CLOTHIERS’ stock currently sells for $20 a share.  The stock just paid a dividend of $1.00 a share (i.e., D0=$1.00).  The dividend is expected to grow at a constant rate of 10 percent a year.  

WHAT STOCK PRICE IS EXPECTED 1 YEAR FROM NOW?  WHAT IS THE REQUIRED RATE OF RETURN ON THE COMPANY’S STOCK?
        

8-4

PREFERRED STOCK VALUATION        FEE FOUNDERS has preferred stock outstanding that pays a dividend of $5 at the end of each year.  The preferred stock sells for $60 a share.  

WHAT IS THE PREFERRED STOCK’S REQUIRED RATE OF RETURN?

8-5

SUPERNORMAL GROWTH VALUATION        HART ENTERPRISES recently paid a dividend, D0, of $1.25.  The company expects to have supernormal growth of 20 percent for 2 years before the dividend is expected to grow at a constant rate of 5 percent.  The firm’s cost of equity is 10 percent.

A.  WHAT YEAR IS THE TERMINAL, OR HORIZON, DATE?

B.  WHAT IS THE FIRM’S HORIZON, OR TERMINAL, VALUE?

C.  WHAT IS THE FIRM’S INTRINSIC VALUE OF TODAY,  ?

    
8-6

CORPORATE VALUE MODEL        SMITH TECHNOLOGIES is expected to generate $150 million in free cash flow next year, and is expected to grow at a constant rate of 5 percent per year.  The firm has no debt or preferred stock and has a WACC of 10 percent.  

IF SMITH HAS 50 MILLION SHARES OF STOCK OUTSTANDING, WHAT IS THE VALUE OF THE COMPANY’S STOCK PER SHARE?

8-7

CORPORATE VALUE MODEL        Due to the highly specialized nature of the electronic industry, BARRETT INDUSTRIES invests a lot of money in R&D on prospective products.  Consequently, it retains all of its earnings and reinvests them into the firm.  (In other words, it does not pay any dividends.)  AT this time, Garrett does not have plans to pay any dividends in the near future.  A major pension fund is interested in purchasing Barrett’s stock, which is traded on the NYSE.  The treasurer of the pension fund has done a great deal of research on the company and realizes that its valuation must be based on the total company model.  The pension fund’s treasurer has estimated Barrett’s free cash flows for the next 4 years as follows:  $3 million, $6 million, $10 million, and $15 million.  After the fourth year, free cash flow is projected to grow at a constant 7 percent.  Barrett’s WACC is 12 percent, it has$60 million of total debt and preferred stock, and 10 million shares of common stock.

        a.    WHAT IS THE PRESENT VALUE OF BARRETT’S FREE CASH FLOWS DURING THE NEXT 4 YEARS?

        b.    WHAT IS THE COMPANY’S TERMINAL VALUE?

        c.    WHAT IS THE TOTAL VALUE OF THE FIRM TODAY?

        d.    WHAT IS BARRETT’S PRICE PER SHARE?

8-10

CONSTANT GROWTH VALUATION        You are considering an investment in the common stock of KELLER CORP.  The stock is expected to pay a dividend of $2 a share at the end of the year (D1=$2.00).  The stock has a beta equal to 0.9.  The risk-free rate is 5.6 percent, and the market risk premium is 6 percent.  The stock’s dividend is expected to grow at some constant rate g.  The stock currently sells for $25 a share.  

ASSUMING THE MARKET IS IN EQUILIBRIUM, WHAT DOES THE MARKET BELIEVE WILL BE THE STOCK PRICE AT THE END OF 3 YEARS?  (That is, what is  ?)

8-11
PREFERRED STOCK RATE OF RETURN        WHAT WILL BE THE NOMINAL RATE OF RETURN ON A PREFERRED STOCK WITH A $100 PAR VALUE, A STATED DIVIDEND OF 8 PERCENT OF PAR, AND A CURRENT MARKET PRICE OF 

(A) $60, 

(B) $80, 

(C) $100, 

(D) $140?

8-12

DECLINING GROWTH STOCK VALUATION        MARTELL MINING COMPANY’S ore reserves are being depleted, so its sales are falling.  Also, its pit is getting deeper each year, so its costs are rising.  As a result, the company’s earnings and dividends are declining at the constant rate of 5 percent per year.  

IF  , WHAT IS THE VALUE OF MARTELL MINING’S STOCK?

8-17

CONSTANT GROWTH EVALUATION        A stock is expected to pay a dividend of $0.50 at the end of the year (that is, D  = 0.50).  The dividend is expected to grow at a constant rate of 7 percent a year.  The stock has a required return of 12 percent.  

WHAT IS THE EXPECTED PRICE OF THE STOCK 4 YEARS FROM TODAY?

8-18

PREFERRED STOCK VALUATION        EZZEL CORPORATION issued preferred stock with a stated dividend of 10 percent of par.  Preferred stock of this type currently yields 8 percent, and the par value is $100.  Assume dividends are paid annually.
        a.    WHAT IS THE VALUE OF EZZELL’S PREFERRED STOCK?

        b.    SUPPOSE INTEREST RATE LEVELS RISE TO THE POINT WHERE THE PREFERRED STOCK NOW YIELDS 12 PERCENT.  WHAT WOULD BE THE VALUE OF EZZELL’S PREFERRED STOCK?

8-19

CONSTANT GROWTH STOCK VALUATION        Your broker offers to sell you some shares of BAHNSEN & CO. common stock that paid a dividend of $2 yesterday.  You expect the dividend to grow at the rate of 5 percent per year for the next 3 years, and, if you buy the stock, you plan to hold it for 3 years and then sell it.

        a.    Find the expected dividend for each of the next 3 years; that is, calculate D1, D2, and D3.  Note that D0=$2.00.

        b.    Given that the appropriate discount rate is 12 percent and that the first of these dividend payments will occur 1 year from now, find the present value of the dividend stream; that is, calculate the PV of D1, D2, and D3, and then sum these PVs.

        c.    You expect the price of the stock 3 years from now to be $34.73; that is, you expect   to equal $34.73.  Discounted at a 12 percent rate, what is the present value of this expected future stock price?  In other words, calculate the PV of $34.73.

        d.    If you plan to buy the stock, hold it for 3 years, and then sell it for $34.73, what is the most you should pay for it today?

        e.    Use Equation 8-2 to calculate the present value of this stock.  Assume that g=5%, and it is constant.

        f.    Is the value of this stock dependent upon how long you plan to hold it?  In other words, if your planned holding period were 2 years or 5 years rather than 3 years, would this affect the value of the stock today,  ?

8-20

CONSTANT GROWTH STOCK VALUATION        Investors require a 15 percent rate of return on LEVINE COMPANY’S stock (k  = 15%).  We are asked to determine what Levine Company stock value ought to be if its cost of equity capital (ks…also the required return for retained earnings) is 15% and a most recent paid dividend of $2.00 (Do).  We are to consider the various values for its stock using four different growth rates (g) of   

1.     - 5 %    
2.       0%   
3.    + 5 %   
4.  + 10%  

        a.    WHAT WILL BE LEVINE’S STOCK VALUE IF THE PREVIOUS DIVIDEND WAS D  = $2 AND IF INVESTORS EXPECT DIVIDENDS TO GROW AT A CONSTANT COMPOUND ANNUAL RATE OF 

(1)    -5 %
(2)      0 %
(3)      5 %
(4)    10 %

        b.    Using the data from part a, what is the Gordon (constant growth) model value for Levine’s stock if the required rate of return is 15 percent and the expected growth rates is

(5)    15 %
(6)    20 %

ARE THESE REASONABLE RESULTS?  EXPLAIN.  

        c.    IS IT REASONABLE TO EXPECT THAT A CONSTANT GROWTH STOCK WOULD HAVE G › K ?