FINA HW #6 - Homework questions answered from the textbook. PDF

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Homework questions answered from the textbook....

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FINA 3001 - Sec 006 Homework #6 Chapter 7, Question 4 4. Assume Evco, Inc. has a current stock price of $50 and will pay a $2 dividend in one year; its equity cost of capital is 15%. What price must you expect Evco stock to sell for immediately after the firm pays the dividend in one year to justify its current price? Answer: P0 = $50 DIV1 = $2 r = 15% Find P1 P0 = (DIV1 + P1)/(1+r) $50 = ($2 + P1)/(1+0.15) = 57.5 = $2 + P1 ⇒ $55.50

Chapter 7, Question 12 12. NoGrowth Corporation currently pays a dividend of $0.50 per quarter, and it will continue to pay this dividend forever. What is the price per share of NoGrowth stock if the firm’s equity cost of capital is 15%. Answer: Quarterly = (1+.15)^(¼) - 1 ⇒ r = 0.0356 P = $0.50/0.0356 = $14.06

Chapter 7, Question 14 14. Dorpac Corporation has a dividend yield of 1.5%. Its equity cost of capital is 8%, and its dividends are expected to grow at a constant rate. a. What is the expected growth rate of Dorpac’s dividends? b. What is the expected growth rate of Dorpac’s share price? Answer: a. Growth Rate of Dividends i.

P0 = DIV/r-g 1. r - g = DIV/P0 ⇒ g = r - DIV/P0

ii.

g = 0.08 - 0.015 = 0.065 or 6.5%

b. Growth Rate of Share Price i.

Same as dividend because they are growing at a constant rate = 0.065 or 6.5%

Chapter 7, Question 16 16. DFB, Inc. expects earnings at the end of this year of $5 per share, and it plans to pay a $3 dividend to shareholders (assume that is one year from now). DFB will retain $2 per share of its earnings to reinvest in new projects that have an expected return of 15% per year. Suppose DFB will maintain the same dividend payout rate, retention rate, and return on new investments in the future and will not change its number of outstanding shares. a. What growth rate of earnings would you forecast for DFB? b. If DFB’s equity cost of capital is 12%, what price would you estimate for DFB stock today? c. Suppose instead that DFB paid a dividend of $4 per share at the end of this year and retained only $1 per share in earnings. That is, it chose to pay a higher dividend instead of reinvesting in as many new projects. If DFB maintains this higher payout rate in the future, what stock price would you estimate for the firm now? Should DFB raise its dividend? Answer: a. Growth Rate of Earnings i.

g = retention rate x return on investment ⇒ ($2/$5) x 0.15 = 0.06 or 6% 1. Retention Rate = Earnings Retained/Total Earnings = ($2/$5)

b. Price Estimate for Stock Today i.

P0 = DIV/r-g 1. P0 = $3/(.12-.06) ⇒ $50.00

c. Estimation Now i. ii.

g = ($1/$5) x 0.15 = 0.03 or 3% P0 = $4/(.12-.03) = $44.44, No do not raise the dividend because it is shown that it is more profitable and creates more value for DFB to pay lower dividends and retained earnings to invest.

Chapter 7, Question 18 18. Assume Gillette Corporation will pay an annual dividend of $0.65 one year from now. Analysts expect this dividend to grow at 12% per year thereafter until the fifth year. After then, growth will level off at 2% per year. According to the dividend-discount model, what is the value of a share of Gillette stock if the firm’s equity cost of capital is 8%? Answer: From Excel Sheet:

Value of Share (P0) = $15.07

Chapter 7, Question 20 20. Assume Highline Company has just paid an annual dividend of $0.96. Analysts are predicting an 11% per year growth rate in earnings over the next five years. After then, Highline’s earnings are expected to grow at the current industry average of 5.2% per year. If Highline’s equity cost of capital is 8.5% per year and its dividend payout ratio remains constant, for what price does the dividend-discount model predict Highline stock should sell? Answer: From Excel Sheet:

Sell it at $39.44

Chapter 7, Question 26 26. Suppose Compco Systems pays no dividends but spent $5 billion on share repurchases last year. If Compco’s equity cost of capital is 12%, and if the amount spent on repurchases is expected to grow by 8% per year, estimate Compco’s market capitalization. If Compco has 6 billion shares outstanding, to what stock price does this correspond? Answer: Market Capitalization: P0 = DIV1/(r-g) P0 = (5 x (1.08))/(0.12-0.08) = 135 Corresponding Stock Price: Share Price = Market Value/# Shares Share Price = 135/5 = $22.50

Chapter 10, Question 6 6. Heavy Metal Corporation is expected to generate the following free cash flows over the next five years.

After 5 years, the free cash flows are expected to grow at the industry average of 4% per year. Using the discounted free cash flow model and a weighted average cost of capital of 14%: a. Estimate the enterprise value of Heavy Metal. b. If Heavy Metal has no excess cash, debt of $300 million, and 40 million shares outstanding, estimate its share price. Answer: a. Enterprise Value of Heavy Metal = $681.37

i. b. Share Price Estimate = $9.53

i.

Chapter 10, Question 8a 8a. Sora Industries has 60 million outstanding shares, $120 million in debt, $40 million in cash, and the following projected free cash flow for the next four years:

a. Suppose Sora’s revenues and free cash flow are expected to grow at a 5% rate beyond year 4. If Sora’s weighted average cost of capital is 10%, what is the value of Sora stock based on this information? Answer: a. Value of Sora Stock: P0 = $10.93, V0 = $735.81

Chapter 10, Question 11 11. You notice that Coca-Cola has a stock price of $41.09 and EPS of $1.89. Its competitor PepsiCo has EPS of $3.90. But, Jones Soda, a small batch craft soda producer has a P/E ratio of 35. Based on this information, what is one estimate of the value of a share of PepsiCo stock? Answer: Coca-Cola P/E Ratio = MPS/EPS ⇒ $41.09/$1.89 = $21.74 PepsiCo Stock: EPS x P/E ratio ⇒ $3.90 x 21.74 = $84.79

Chapter 10, Question 12

12. CSH has EBITDA of $5 million. You feel that an appropriate EV/EBITDA ratio for CSH is 9. CSH has $10 million in debt, $2 million in cash, and 800,000 shares outstanding. What is your estimate of CSH’s stock price? Answer: P0 = V0 + (Cash - Debt)/Shares Outstanding and EV/$5 million = 9 ⇒ EV = 9 x 5 million = $45 million Stock Price = Enterprise Value + Cash - Debt/# Shares Outstanding 45,000,000 + 2,000,000 - 10,000,000/800,000 = $46.25

Chapter 10, Question 24 24. Roybus, Inc., a manufacturer of flash memory, just reported that its main production facility in Taiwan was destroyed in a fire. Although the plant was fully insured, the loss of production will decrease Roybus’s free cash flow by $180 million at the end of this year and by $60 million at the end of next year. a. If Roybus has 35 million shares outstanding and a weighted average cost of capital of 13%, what change in Roybus’s stock price would you expect upon this announcement? (Assume the value of Roybus’s debt is not affected by the event.) b. Would you expect to be able to sell Roybus stock on hearing this announcement and make a profit? Explain. Answer: a. Change in Stock Price i.

PV Loss = (FCF1/(1+r)) + (FCF2/(1+r)^2) 1. PV Loss = (($180 million)/(1+.13)) + (($60 million)/(1+.13)^2) = ($206.28)million 2. Change in Stock Price = PV Loss/# Shares = ($206.28 million)/35 million shares = ($5.89)

b. Based on the negative cash flows for the current year and the projected for the next year and the fact that the price of the share will drop, the trading of shares is not possible. Thus, Roybus cannot sell and make a profit....