Problem Set II
Problem P9 17:
Jack Hammer
FV (Table 1) at 11% discount rate
2.00 x .901 = $1.80
2.20 x .802 = $1.79
2.40 x .731 = $1.75
33.00 x .731 = $24.12 -------- $29.46
Problem P9 - 22:
Alternative Present Values: Your rich godfather has offered you a choice of one of the three following alternatives: $10,000 now; $2,000 a year for eight years; or $24,000 at the end of eight years.
Solution:
(first alternative) Present value of 10,000 received now: 10,000
(second alternative) Present Value of annuity of 2,000 for eight years:
Appendix D
PVa=AxPVifa
=2,000xPVifa (11%,8years)
=2,000x5.146
=10,292
(third alternative) Present value of 24,000 received
…show more content…
The preferred stock price will increase
Problem P10 21:
Analogue Technology has preferred stock outstanding that pays an annual dividend of $12. It has a price of $110. What is the required rate of return (yield) on the preferred stock? Pp = Dp / Kp in reverse Kp = Dp / Pp Kp= 12 / 110 = .109 = 11 %
Problem P10 24:
Friedman Steel Company will pay a dividend of $1.50 per share in the next 12 months (D1). The required rate of return (Ke) is 10 percent and the constant growth rate is 5 percent.
For Problem 24 we computed the present value of shares of common stock with a constant growth return. Problem 24 breaks down as follows:
Po = present value of common stock with constant growth returns
Do = most recent per-share dividend, which is $1.50 in this scenario
Ke = required return or the discount rate for each year, which is 10% g = constant growth rate or rate of growth, which is 5%
A. Compute Po
Po =Do (1 + g)1 / (1 + Ke)1, [$1.50 (1 + .05)1 / (1 + .10)1 = [$1.575 / (1 + .10)1] = $1.43 (PV of expected future returns using the Discounted Cash Flow formula ("DCF") which leads to the Constant Growth formula as follows:
Answer: Po = D1 / (Ke - g), [$1.43 / (.10 - .05)] = $28.60
For parts b, c, and d in this problem all variables remain the same except the one specifically changed. Each question is independent of the others.)
B. Assume Ke, the required rate of
r = rf + β [E(rm ) − rf ] = 1.50% + 1.1 (7.50% − 1.50%) = 8.1% .
-Martin Industries just paid an annual dividend of $1.30 a share. The market price of the stock is $36.80 and the growth rate is 6.0 percent. What is the firm's cost of equity?
EPS Growth Rate: These values are also found in exhibit 6, leading to g = 5.55%
These are the automatically computed results of your exam. Grades for essay questions, and comments from your instructor, are in the "Details" section below.
(TCO D) A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?
In this case, to get the present value (PV), we can use the formula of growing annuity.
-14.69-7.29) + (-26.47-7.99) + (37.23 – 5.87) + (23.93 – 5.07) + (-7.16 – 5.45) + (6.57- 7.64) = -19.9%
Notice that the PV in 2004 remains at 16.82. This makes sense, since the value of a firm should not depend on the investment horizon chosen for valuation. We have reduced ROE to the 10 cost of capital after 2010, assuming that the company will have exhausted valuable growth opportunities by that date. With PVGO 0, PV EPS/r. So we could discard the constant-growth DCF formula and just divide EPS in 2011 by the cost of capital The keys to the companys future value and growth are profitability (ROE) and the reinvestment of retained earnings. Retained earnings are determined by dividend payout. The spreadsheet sets ROE at 15 for the five years from 2006 to 2010. If Reeby Sports will lose its competitive edge by 2011, then it cannot continue earning more than its 10 cost of capital. Therefore ROE is reduced to 10 starting in 2011.... 1. Special onetime dividend affects the value of the firm in both positive and negative ways. Value of the firm increases when Special dividend is paid from increase in operating cash flow (It suggests that company requires less investment and is generating good cash flow from operations). In our case company has a surplus cash of 30 million from sale of its design and if it pays special dividend. Stock price would initially rise owing to the information of huge dividend payments in market but will adjust in
3. C is correct. First calculate the growth rate using the sustainable growth calculation, and
5) Mashrafee Inc. is expected to grow at a constant rate of 6 percent and its dividend yield is 7 percent. The company is about as risky as the average firms are in the industry. However, the company just successfully completed some R&D work that leads the company to expect that its earnings will grow at a rate of 50 percent this year and 25 percent the following year, after which growth should match the 6 percent industry average rate. The last dividend paid (D0) was $1.00. What is the value per share of the firm’s stock?
The present value of expected cash outflows is greater than the present value of expected cash inflows
Problem B was similar in concept to that of Problem A. However, a more realistic discount rate was involved. In this instance, the investor had a required rate of return of 5%. Through the calculations, the NPV was ultimately positive. As such, the investor should provide the initial cash outlay.
Note: Attempt all the questions. All questions carry equal marks. Correct answers should be marked by darkening the circles in the answer sheet provided.
The dividend growth model is used to find the value of a stock whose dividend is expected to grow at a constant rate. The three dividend growth models are, zero-growth, constant growth, and non-constant growth. Since dividends grow at a constant rate, companies use their cost of capital as a discount rate, and the growth rate of the company must exceed its cost of capital. For example, ABC, Inc. just paid a dividend of $.50. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets of this risk, the stock would be selling for: P= .50(1+.02) / (.15-.02) = $3.92. It’s smooth out pattern for constant percentage change each year. Constant percentage change allows for a simplified pricing model.
The payout ratio is set at .30 from 2006 onwards. Notice that the long-term growth rate, which settles in between 2011 and 2012, is ROE × ( 1 – dividend payout ratio ) = .10 × (1 - .30) = .07.