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Homework 9 Multiple Choice Identify the choice that best completes the statement or answers the question. ____

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1. If D1 $2.00, g (which is constant) 6%, and P0 $40, what is the stock's expected dividend yield for the coming year? A. 5.0% B. 6.0% C. 7.0% D. 8.0% E. 9.0% 2. If D1 $2.00, g (which is constant) 6%, and P0 $40, what is the stock's expected capital gains yield for the coming year? A. 5.2% B. 5.4% C. 5.6% D. 5.8% E. 6.0% 3. If D1 $2.00, g (which is constant) 6%, and P0 $40, what is the stock's expected total return for the coming year? A. 10.8% B. 11.0% C. 11.2% D. 11.4% E. 11.6% 4. A stock is expected to pay a dividend of $1 at the end of the year. The required rate of return is r s 11%, and the expected constant growth rate is 5%. What is the current stock price? A. $16.67 B. $18.83 C. $20.00 D. $21.67 E. $23.33 5. A stock just paid a dividend of $1. The required rate of return is rs 11%, and the constant growth rate is 5%. What is the current stock price? A. $15.00 B. $17.50 C. $20.00 D. $22.50 E. $25.00

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6. Hahn Manufacturing is expected to pay a dividend of $1.00 per share at the end of the year (D1 $1.00). The stock sells for $40 per share, and its required rate of return is 11%. The dividend is expected to grow at a constant rate, g, forever. What is Hahn's expected growth rate? A. 8.00% B. 8.50% C. 9.00% D. 9.50% E. 10.00% 7. Damon Enterprises' stock currently sells for $25 per share. The stock's dividend is projected to increase at a constant rate of 7% per year. The required rate of return on the stock, rs, is 10%. What is Damon's expected price 4 years from today? A. $30.21 B. $31.65 C. $32.77 D. $33.89 E. $34.45 8. P. Daves Inc's stock is currently sells for $45 per share. The stock's dividend is projected to increase at a constant rate of 4% per year. The required rate of return on the stock, rs, is 12%. What is Daves' expected price 6 years from now? A. $52.68 B. $53.71 C. $54.41 D. $55.12 E. $56.94 9. The Corrigan Company just paid a dividend of $1 per share, and that dividend is expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.2, the market risk premium is 5%, and the risk-free rate is 3%. What is the company's current stock price? A. $19.25 B. $21.00 C. $22.75 D. $24.50 E. $26.25 10. Wald Inc's stock has a required rate of return of 10%, and it sells for $40 per share. Wald's dividend is expected to grow at a constant rate of 7% per year. What is the expected year-end dividend, D1? A. $0.90 B. $1.00 C. $1.10 D. $1.20 E. $1.30 11. Bettis Corp.'s stock price is $20 per share, and its expected year-end dividend is $2 a share (D1 $2.00). The stock's required return is 15%, and the dividend is expected to grow at a constant rate forever. What is the expected price of the stock 7 years from now? A. $27.18 B. $28.14 C. $29.95 D. $30.45 E. $31.81

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____ 12. You must estimate the intrinsic value of Gallovits Technologies' stock. Gallovits's end-of-year free cash flow (FCF) is expected to be $25 million, and it is expected to grow at a constant rate of 8.5% a year thereafter. The company's WACC is 11%. Gallovits has $200 million of long-term debt plus preferred stock, and there are 30 million shares of common stock outstanding. What is Gallovits' estimated intrinsic value per share of common stock? A. $22.67 B. $24.00 C. $25.33 D. $26.67 E. $28.00 ____ 13. You have been assigned the task of using the corporate valuation model to estimate Meric Corporation's intrinsic value. Meric's WACC is 10%, its end-of-year free cash flow (FCF) is expected to be $75 million, the FCFs are expected to grow at a constant rate of 5.5% a year in the future, the company has $400 million of long-term debt plus preferred stock, and it has 50 million shares of common stock outstanding. What is the company's estimated intrinsic value per share of common stock? A. $25.33 B. $26.67 C. $28.00 D. $29.33 E. $30.67 ____ 14. Motor Homes Inc. (MHI) is presently enjoying abnormally high growth because of a surge in the demand for motor homes. The company expects earnings and dividends to grow at a rate of 20% for the next 4 years, after which there will be no growth (g 0) in earnings and dividends. The company's last dividend, D0, was $1.50. MHI's beta is 1.5, the market risk premium is 6%, and the risk-free rate is 4%. What is the current price of the common stock? A. $17.51 B. $19.63 C. $21.66 D. $23.57 E. $25.87 ____ 15. The Connors Company's last dividend was $1.00. Its dividend growth rate is expected to be constant at 15% for 2 years, after which dividends are expected to grow at a rate of 10% forever. Connors' required return (r s) is 12%. What is Connors' current stock price? A. $54.91 B. $56.82 C. $58.15 D. $60.07 E. $62.87 ____ 16. The Ehrhardt Company's last dividend was $2.00. The dividend growth rate is expected to be constant at 3% for 2 years, after which dividends are expected to grow at a rate of 8% forever. Erhardt's required return (rs) is 12%. What is Erhardt's current stock price? A. $49.20 B. $51.40 C. $53.80 D. $55.10 E. $57.30

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____ 17. For the stock market to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels, A. Expected future returns must be equal to required returns (r r). r). B. The past realized return must be equal to the expected future return ( C. The required return must equal the realized return (r r ). D. The expected return must be equal to both the required future return and the past realized return (r r r ). E. If the expected future return is less than the most recent past realized return, then stocks are most likely to decline. ____ 18. Johnston Corporation is growing at a constant rate of 6% per year. The cost of preferred stock (r p) is 8%. The par value of the preferred stock is $120, and the stock has a stated dividend of 10% of par. What is the market value of the preferred stock? A. $125 B. $120 C. $175 D. $150 E. $200 ____ 19. Cartwright Brothers' stock is currently selling for $40 a share. The stock is expected to pay a $2 dividend at the end of the year. The dividend growth rate is expected to be a constant 7% per year, forever. The risk-free rate and market risk premium are each 6%. What is the stock's beta? A. 1.06 B. 1.00 C. 2.00 D. 0.83 E. 1.08 ____ 20. You are given the following data: The risk-free rate is 5%. The required return on the market is 8%. The expected growth rate for the firm is 4%. The last dividend paid was $0.80 per share. Beta is 1.3. Now assume the following changes occur: The inflation premium drops by 1%. An increased degree of risk aversion causes the required return on the market to rise to 10% after adjusting for the changed inflation premium. The expected growth rate increases to 6%. Beta rises to 1.5. What will be the change in price per share, assuming the stock was in equilibrium before the changes occurred? A. $12.11 B. -$ 4.87 C. $ 6.28 D. -$16.97 E. $ 2.78 4

____ 21. Mack Industries just paid a dividend of $1.00 per share (D0 $1.00). Analysts expect the company's dividend to grow 20% this year (D1 $1.20) and 15% next year. After two years the dividend is expected to grow at a constant rate of 5%. The required rate of return on the company's stock is 12%. What should be the company's current stock price? A. $12.33 B. $16.65 C. $16.91 D. $18.67 E. $19.67 ____ 22. A stock is expected to pay a dividend of $1.00 at the end of the year (i.e., D1 $1.00), which is expected to grow 25% in each of the following two years and at a constant rate of 6%, thereafter. If the stock's required return is 11%, what is the stock's price today? A. $26.14 B. $27.28 C. $30.48 D. $32.71 E. $35.38 ____ 23. Lamonica Motors just reported EPS of $2.00. The stock has a P/E ratio of 40, so the stock's current price is $80 per share. Analysts expect that one year from now the company will have an EPS of $2.40, and it will pay its first dividend of $1.00 per share. The stock has a required return of 10%. What P/E ratio must the stock have one year from now so that investors realize their expected return? A. 44.00 B. 36.25 C. 4.17 D. 40.00 E. 36.67 ____ 24. An analyst has collected the following information about Franklin Electric: Projected EBIT for the next year $300 million. Projected depreciation expense for the next year $50 million. Projected capital expenditures for the next year $100 million. Projected increase in operating working capital next year $60 million. Tax rate 40%. WACC 10%. Cost of equity 13%. Market value of debt and preferred stock today $500 million. Number of shares outstanding today 20 million. The company's free cash flow is expected to grow at a constant rate of 6% a year. The analyst uses the corporate value model approach to estimate the stock's intrinsic value. What is the stock's intrinsic value today? A. $ 87.50 B. $212.50 C. $110.71 D. $ 25.00 E. $ 62.50

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____ 25. The Tapley Tank Company's last dividend was $2.00. The dividend growth rate is expected to be constant at 25% for 3 years, after which dividends are expected to grow at a rate of 7% forever. Tapley's required return (rs) is 11%. What is Tapley's current stock price? A. $80.64 B. $82.45 C. $84.05 D. $86.16 E. $88.45 ____ 26. The P. Born Company's last dividend was $1.50. The dividend growth rate is expected to be constant at 20% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If Born's required return (rs) is 13%, what is the company's current stock price? A. $25.16 B. $27.89 C. $28.26 D. $30.34 E. $32.28 ____ 27. The D. Wagner Company's last dividend was $1.00. The dividend growth rate is expected to be constant at 20% for 2 years, after which dividends are expected to grow at a rate of 6% forever, and the current stock price is $35. What is Wagner's required return, r s? (Hint: This problem is hard, and it is really feasible only for with students with computer access.) A. 9.56% B. 9.87% C. 10.04% D. 10.23% E. 10.48% ____ 28. The last dividend paid by Klein Company was $1.00. Klein's growth rate is expected to be a constant 5% for 2 years, after which dividends are expected to grow at a rate of 10% forever. Klein's required return (r s) is 12%. What is the current price of Klein's common stock? A. $21.00 B. $33.33 C. $42.25 D. $50.16 E. $58.75 ____ 29. Your company just paid a dividend of $2.00. The dividend growth rate is expected to be 4% for 1 year, 5% the next year, then 6% for the following year, and a constant 7% thereafter. The stock's required return (r s) is 10%. What is the current stock price? A. $53.45 B. $60.98 C. $64.49 D. $67.47 E. $69.21

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____ 30. An analyst is estimating the intrinsic value Harkleroad Technologies' stock. Harkleroad's free cash flow is expected to be $25 million this year, and grow at a constant rate of 7% a year. The company's WACC is 10%. Harkleroad has $200 million of long-term debt and preferred stock, and 30 million outstanding shares of common stock. What is the estimated per-share price of Harkleroad Technologies' common stock? A. $ 1.67 B. $ 5.24 C. $18.37 D. $21.11 E. $27.78 ____ 31. An analyst estimating the intrinsic value of the Rein Corporation stock estimates that its free cash flow at the end of the year (t 1) will be $300 million. The analyst estimates that the firm's free cash flow will grow at a constant rate of 7% a year, and that the company's WACC is 11%. The company currently has debt and preferred stock totaling $500 million and 150 million outstanding shares of common stock. What is the intrinsic value (per share) of the company's stock? A. $16.67 B. $25.00 C. $33.33 D. $46.67 E. $50.00 ____ 32. DAA's stock is selling for $15 per share. DAA has yet to pay a dividend, but the firm intends to declare a $2.00 dividend at the end of the third year. After the third year, dividends are expected to grow at a long-term growth rate of 6%. If the firm's required return is 18%, the stock is A. Undervalued by $3.03. B. Overvalued by $3.03. C. Correctly valued. D. Overvalued by $2.25. E. Undervalued by $2.25. ____ 33. Today is December 31, 2005. The following information applies to Addison Airlines: After-tax, operating income for 2006 is expected to be $400 million. The firm's 2006 depreciation expense is expected to be $80 million. The firm's 2006 capital expenditures are expected to be $160 million. No change is expected in the company's net operating working capital. The firm's free cash flow is expected to grow at a constant rate of 5% per year. The company's cost of equity is 14%. The company's WACC is 10%. The current market value of the company's debt is $1.4 billion. The company currently has 125 million shares of stock outstanding. Using the free cash flow valuation method, what should be the company's stock price today? A. $ 40 B. $ 50 C. $ 25 D. $ 85 E. $100

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____ 34. Keane Tech's operating income (EBIT) for the next year is expected to be $800 million. Analysts think Keane will require $255 million in gross capital expenditures next year, the depreciation expense is expected to be $75 million, and no changes in net operating working capital are expected. Free cash flow is expected to grow at a constant rate of 6% per year. The company's WACC is 9%, its cost of equity is 14%, and its before-tax cost of debt is 7%. The company has $900 million of debt, $500 million of preferred stock, and has 200 million outstanding shares of common stock. The firm's tax rate is 40%. Using the free cash flow valuation method, what is the predicted price of the stock today? A. $ 11.75 B. $ 43.00 C. $ 55.50 D. $ 96.33 E. $108.83 ____ 35. An analyst is estimating Burress Inc.'s intrinsic value. The analyst has estimated the company's free cash flows for the following years: Year 1 2 3

Free Cash Flow $3,000 4,000 5,000

The analyst estimates that after three years, free cash flow will grow at a constant rate of 6% per year. The analyst estimates that the company's WACC is 10%. The company's debt and preferred stock has a total market value of $25,000 and there are 1,000 outstanding shares of common stock. What is the (per-share) intrinsic value of the company's common stock? A. $ 78.31 B. $ 84.34 C. $ 98.55 D. $109.34 E. $112.50

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ID: A

Homework 9 Answer Section MULTIPLE CHOICE 1. ANS: A

TOP: Expected dividend yield 2. ANS: E

TOP: Expected return, dividend yield, and capital gains yield 3. ANS: B

TOP: Expected total return 4. ANS: A

TOP: Constant growth valuation 5. ANS: B

TOP: Constant growth valuation

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ID: A 6. ANS: B

TOP: Constant growth rate 7. ANS: C

TOP: Future price of a constant growth stock 8. ANS: E

TOP: Future price of a constant growth stock 9. ANS: E

TOP: Constant growth valuation; CAPM 10. ANS: D

TOP: Constant growth dividend

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ID: A 11. ANS: B

TOP: Future price of a constant growth stock 12. ANS: D

TOP: Corporate valuation model 13. ANS: A

TOP: Corporate valuation model

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ID: A 14. ANS: C

TOP: Nonconstant growth stock price 15. ANS: D

TOP: Nonconstant growth stock price 16. ANS: A

TOP: Nonconstant growth stock price 17. ANS: A TOP: Market equilibrium

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ID: A 18. ANS: D Annual dividend 10% $120 Vp Dp/rp $12/0.08 $150.

$12.

TOP: Preferred stock value 19. ANS: B Step 1: Find rs: rs D1/P0 g rs $2/$40 0.07 rs 0.12. Step 2:

Use the CAPM to find beta: r s rRF RPM(b) 0.12 0.06 0.06(b) b 1.

TOP: Beta coefficient 20. ANS: B Before: r s 5% (8% 5%)1.3 8.9%. $0.80(1.04) $16.98. P0 0.089 0.04 After:

rs P0

4% (10% 4%)1.5 13%. $0.80(1.06) $12.11. 0.130 0.06

Hence, we have $12.11

$16.98

-$4.87.

TOP: Equilibrium stock price

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ID: A 21. ANS: D First, find the stock price after two years: D1 D2 D3

$1.20. $1.20 1.15 $1.38 1.05

P 2

D3/(rs g) $1.449/(0.12 $20.70.

$1.38. $1.449.

0.05)

Next, determine the dividends during the nonconstant growth period: D1 $1.00 1.2 $1.20. D2 $1.20 1.15 $1.38. Finally, determine the company's current stock price: Numerical solution: $1.20 $1.38 $20.70 P0 $18.67 1.12 (1.12) 2 Financial calculator solution: Enter in CFLO register CF0 0, CF1 NPV P0 $18.67.

1.20, and CF2

TOP: Nonconstant growth stock

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22.08. Then enter I/YR

12, and press NPV to get

ID: A 22. ANS: B Step 1:

Calculate dividends during the nonconstant period and the first year of constant growth: D1 $1.00. D2 $1.00 1.25 $1.25. D3 $1.00 (1.25)2 $1.5625. D4 $1.00 (1.25)2 1.06 $1.65625.

Step 2:

Calculate the price of the stock once growth is constant (which would be at the end of the third year). D4 $1.65625 $33.125 . P 3 rs g 0.11 0.06

Step 3:

P0

($33.125 $1.5625) $1.25 3 2 (1.11) (1.11) $0.9009 $1.0145 + $25.3632 $27.2786 $27.28. $1.00 1.11

Financial calculator solution: CF0 0; CF1 1.00; CF2 1.25; CF3

33.125

1.5625

34.6875; I/YR

11; and then solve for NPV

$27.28. TOP: Nonconstant growth stock 23. ANS: B Data given: EPS $2.00; P/E 40x; P0

$80; D1

$1.00; rs

Step 1:

Calculate the price of the stock one year from today: r s D1/P0 (P1 P0)/P0 0.10 $1/$80 (P1 $80)/$80 8 $1 P1 $80 $87 P1.

Step 2:

Calculate the P/E ratio one year from today: P/E $87/$2.40 36.25x.

TOP: Expected return and P/E ratio

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10%; EPS1

$2.40.

P0

ID: A 24. ANS: E Step 1:

Calculate the firm's free cash flows (in millions of dollars) for the next year: FCF1 EBIT(1 T) Dep Cap Exp. NOWC $300(1 0.4) $50 $100 $60 $70 million.

Step 2:

Calculate total firm value (TFV) today: TFV FCF1/(WACC g) $70/(0.10 0.06) $1,750 million.

Step 3:

Calculate the firm's equity value today by subtracting today's market value of the firm's debt and preferred stock: MVE TFV MVD+P $1,750 $500 $1,250 million.

Step 4:

Calculate the firm's price per share today: P0 MVE/# shares $1,250/20 $62.50.

TOP: FCF model for valuing stock 25. ANS: C

TOP: Nonconstant growth stock price

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ID: A 26. ANS: E

TOP: Nonconstant growth stock price 27. ANS: B

TOP: Nonconstant growth stock price 28. ANS: D

Numerical solution: P0 $1.05 $61.742 1.12 (1.12)

$50.16.

Financial calculator solution: Enter in CFLO register CF0 0, CF1 Then enter I/YR

1.05, and CF2

12, and press NPV to get NPV

TOP: Nonconstant growth stock

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P0

61.74. $50.16.

ID: A 29. ANS: D

Numerical solution: $2.08 $2.1840 P0 1.10 (1.10) 2

$84.8848 (1.10) 3

Enter in calculator: CF 0 0; CF1 2.08; CF2

$67.47

2.1840; and CF3

84.8848; I/YR

10; and solve for NPV

P0

$67.47.

TOP: Nonconstant growth stock 30. ANS: D Firm value $25,000,000/(0.10 0.07) $833,333,333. This is the value of the whole company, including debt, preferred stock, and common stock. From this, we subtract the $200,000,000 in debt and preferred stock. This leaves an equity value of $833,333,333 - $200,000,000 $633,333,333. So, the price/share

$633,333,333 30, 000,000

$21.11.

TOP: FCF model for valuing stock 31. ANS: D FCF1 $300,000,000, growth rate 7%, and...