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Recovery for Word 5.0 http://ref.officerecovery.com/word/?5316wr

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rs = 12%gs = 18% gs = 18% gn = 5%WACC = 12% gn = 7%rs = 13% ┶‽ rs = 13% ┰‽ rs = 13%gs = 30% gs = 30% gs = 30% gn = 6% EMBED Equation.3

WACC = 12% ( 1/1.13( 1/(1.13)2( 1/(1.13)3( 1/(1.13)2( 1/(1.13)3( 1/1.13( 1/(1.13)2( 1/(1.13)3( 1/(1.13)3( 1/1.13rs = 14% gs = 50% gn = 8% EMBED Equation.3 ( 1/(1.14)3( 1/(1.14)4( 1/(1.14)5 gn = 7%WACC = 13%( 1/1.13( 1/(1.13)2( 1/(1.13)3rs = 12%

rs = 12%gs = 15% gn = 5% ┵‽ rs = 13% ┰‽ ┰‽ ┰‽ gn = 6% EMBED Equation.3

( 1/(1.13)2( 1/(1.13)3( 1/(1.13)3( 1/1.13WACC = 10% gn = 6% EMBED Equation.3 ( 1/(1.10)2( 1/(1.10)3( 1/(1.10)3( 1/1.10WACC = 12.5% gn = 6%

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Chapter 10Stocks and Their Valuation

Learning Objectives

After reading this chapter, students should be able to:

Discuss the ldemo demo demo demo demo.

Explain the distinction between a stock’s price and its intrinsic value.

Identify the two models that can be used to estimate a stock’s intrinsic value: the discounted dividend model and the corporate model.

List the key characteristics of predemo demo demo demo demo demo demo demo demo demo demo demo demo demo.

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Lecture Suggestions

This chapter provides important and useful information on common and preferred stocks. Moreover, the valuation of stocks reinforces the concepts covered in Chapters 7, 8, and 9, so Chapter 10 extends and reinforces concepts discussed in those chapters.

We begin our lecture with a discussion of the characteristics of common stocks and how stocks ardemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 10, which appears at the end of this chapter solution. For other suggestions about the lecture, please see the “Lecture Suggestions” in Chapter 5, where we describe how we conduct our classes.

DAYS ON CHAPTER: 3 OF 58 DAYS (50-minute periods)

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Answers to demo demo demo demo

10-1 a. The average investor of a firm traded on the NYSE is not really interested in maintaining his or her proportionate share of ownership and control. If the investor wanted to increase his or her ownership, the investor could simply buy more stock on the open market. Consequently, most investors are not concerned with whether new shares are sold directly (at about market prices) or through rights offerings. However, if a rights offering is being used to effect a stock split, or if it is being used to reduce the underwriting cost of an issue (by substantial underpricing), the preemptive right may well be beneficial to the firm and to its stockholders.

b. The preemptive right is clearly important to the stockholders of closely held (private) firms whose owners are interested in maintaining their relative control positions.

10-2 No. The correct equationdemo demo demo demo demo demo demo demo demo demo demo demo.

10-3 Yes. If a company decides to increase its payout ratio, then the dividend yield component will rise, but the expected long-term capital gains yield will decline.

10-4 Yes. The value of a share of stock is the PV of its expected future dividends. If the two investors expect the same future dividend stream, and they agree on the stock’s riskiness, then they should reach similar conclusions as to the stock’s value.

10-5 A perpetual bond is similar to a nodemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo

1. All three derive their values from a series of cash inflows—coupon payments from the perpetual bond, and dividends from both types of stock.

All three are assumed to have indefinite lives with no maturity value (M) for the perpetual bond and no capital gains yield for the stocks.

However, there are preferreds that have a stated maturity. In this situation, the preferred would be demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

10-614 = 0.demo demo) g = 0.053571.D2 = 0.demo demo demo) = 0.684821.P1 = 0.684demo demo demo demo) = 14.75.

10-7 Those cash flows consist of two elements: (1) the dividdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

10-8 The major assumption is r > g.

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demotime 1 3 5demo demo demo demo demo demodemo demo demo demo

demo demo demo

P0 = 2.44/(1 + 11%)4 + demo demo demo demo demo demo demo demo demo = 61.14.5

Solutions to End-of-Chapter Problems

10-1 D0 = $1.25; gdemo demo demo demo demo demo demo?

D1 = D0(1 + g1) = $1.25(1.06) = $1.3250.

D2 = D0(1 + g1)(1 + g2) = $1.25(1.06)2 = $1.4045.

D3 = D0(1 + g1)(1 +demo demo demo demo demo demo demo.

D4 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn) = $1.25(1.06)3(1.04) = $1.5483.

D5 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn)2 = $1.25(1.06)3(1.04)2 = $1.6103.

10-2 = $1.demo demo demo demo

10-3 D1 = $0.55; g = 6%; rs = 12%; RTFDATA Obj104 = ?

RTFDATA Obj105

10-4 P0 = $22; demo demo demo demo RTFDATA Obj106 demo demo?

RTFDATA Obj107 = P0(1 + g) = $22(1.07) = $23.54.

RTFDATA Obj108 = RTFDATA Obj109 + g = + 0.06= + 0.06 demo demo demo demo.

10-5 a. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.

b. 0 1 2 3demo

1.50 1.77 2.09 2.19

demoRTFDATA Obj110

The horizon, or terminal, value is the value at the horizon date of all dividends expected thereafter. In this problem it is calculated as follows:

RTFDATA Obj111

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c. The firm’s intrinsic value is calculated as the sum of the present value of all dividends during the superndemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

10-6 The firm’s free cash flow is expected to grow at a constant rate, hence we can apply a constant growth formula to determine the total value of the firm.

Firm valudemo demo demo)= $145,000,000/(0.12 – 0.06)= $2,demo demo.

To find the value of an equity claim upon the company (share of stock), we must subtract out the market value of debt and preferred stock. This firm happens to be entirely equity funded, and this step is unnecessary. Hence, to find the value of a share of stock, we divide equity value (or in this case, firm value) by the number of shares outstanding.

Equity value per sdemo demo demo demo demo demo demo= $2,416,666,667/50,000,000

= demo.

Each share of common stock is worth $48.33, according to the corporate valuation model.

10-7 Dp = $demo demo demo demo?

rp = RTFDATA Obj112 = RTFDATA Obj113 = 10%.

10-8 Vp = Dp/demo demo demo demo demo.

a. rp = $8/$60 = 13.33%.

b. rp =demo demo demo.

c. rp = $8/$100 = 8.0%.

d. rp = demo demo demo.

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10-9 a. RTFDATA Obj114

RTFDATA Obj115

10-10 a. The preferred stock pays $8demo demo demo demo demo demo demo demo demo demo demo demo demo demo

Nominal ratedemo demo demo demo demo.

Or alternatively, you could ddemo demo demo demo demo demo demo demo demo demo demo.

Periodic ratedemo demo demo demo demo.

Nominal rate demo demo demo demo demo.

b. EAR =demo demo demo

= (1 demo demo= 0.10demo demo demo.

demo

10-12 First, demo demo demo demo demo.

RTFDATA Obj116 = Ddemo demo)= $0.5demo demo demo)= demo.

If the stock is in a constant growth state, the constant dividend growthdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo

RTFDATA Obj117 = Pdemo= $1demo demo= $13.demo demo demo.

10-1demoRTFDATA Obj118

2. RTFDATA Obj119 = $demo demo demo.

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RTFDATA Obj120

4.

b. 1. RTFDATA Obj121 = $2.30/0 = Undefined.

2. RTFDATA Obj122 = $2.40/(-0demo demo demo demo demo demo.These results show that the formula does not make sense if the required rate of return is equal to or less than the expected growth rate.

c. No, the results of Part b show this. It is not reasonable for a firm to grow indefinitely at a rate higher than its required return. Such a stock, in theory, would become so large that it would eventually overtake the whole economy.

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10-14 The problem asks you to determine the value ofdRTFDATA emo demo demo demo demo demo demo

demo demo demo demo demo demo demo demo demo demo demo demo demo demo

Step 1: Calculate the required rate of return:rs = rRF + (rM – rRF)b = 5.6% + (6%)0.9 = 11%.

Step 2: Use the consdemo demo demo demo demo demo demo demo

RTFDATA Obj124

Step 3: Calculate RTFDATA Obj125 :

RTFDATA Obj126 = P0(1 + g)3 =demo demo demo demo demo demo.

Alternatively, you could calculate D4 and then use the constant growth rate formula to solve for RTFDATA Obj127 :D4 = D1(1 + g)3 = $2.00(1.03)3 = $2.1855.

RTFDATA Obj128 = $2.1855/(0.1demo demo demo demo demo demo.

10-15 Calculate the dividend cash flows and place them on a time line. Also, calculate the stock price at the end of the supernormal growth period, and include it, along with the dividend to be paid at t = 5, as CF5. Then, enter the cash flows as shown on the time line into the cash flow register, enter the required rate of return as I/YR = 14, and then find the value of the stock using the NPV calculation. Be sure to enter CF0 = 0, or else your answer will be incorrect.

D0 = 0; D1 = 0; D2 = 0; D3 = 1.00; D4 = 1.00(1.5) = 1.5; D5 = 1.00(1.5)2 = 2.25; D6 = 1.00(1.5)2(1.08) = $2.43. = ?

0 1demo demo| | | | | | |

1.0demo demo demo

0.675demo demo0.88822.2 de mo demo

$23.766 = RTFDATA Obj129

RTFDATA Obj130 = D6/(rs – g) = $2.43/(0.14 –demo demo demo demo demo demo demo demo demo demo demo demo.

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CF0 = 0; CF1-2 = 0; CF3 = 1.0; CF4 = 1.5; CF5 = 40.50; I/YR = 14%.

With these cash flows in the CFLO rdemo demo demo demo demo demo demo demo demo demo demo demo demo demo.

10-16 a. Terminal value = = RTFDATA Obj131 = $713.33 million.

b. 0demo| | | | |

-20demo demo($ 17.70)

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23.4deRTFDATA mo demo

522.10 753.33demo

Using a financial calculator, enter the following inputs: CF0 = 0; CF1 = -20; CF2 = 30; CF3 = 753.33; I/YR = 13; and then solve for NPV = $527.89 million.

c. Total valdemo demo demo demo.

Value of common equity = $527.89 – $100 = $427.89 million.

Price perdemo demoRTFDATA Obj133 demo.

10-17 The value of any asset is the present value of all future cash flows expected to be generated from the asset. Hence, if we can fdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

D1 = $2.00 ( (1.25)1demo demo demo demo demo demo demo demoD2 = $2.00 ( (1.25)2 demo demo demo demo demo demo demo demo

D3 = $2.00 ( (1.25)3 =demo demo demo demo demo demo demo demo demo

( PV(D1demo demo demo

Therefore, the PV of the remaining dividends is: $58.8800 – $7.5038 = $51.3762. Compounding this value forwdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo

= D3(demo demo demo)$72.18 = $3demo demo demo demo)

$8.6616 – $7demo demo demo demo demo$4.755demo demo0.demo6.demo.

10-18demo demo| demo

D0 = 2.demo demo

RTFDATA Obj134

a. D1 = $2(1.05) = $2.10; demo demo demo demo demo demo demo demo demo demo.

b. Financial calculator solution: Input 0, 2demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

c. Financial calculator solution: Inputdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

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d. $24.72 + $5.28 = $30.demo demo demo demo demo demo demo demo demo.

e. RTFDATA Obj135

f. No. The value of the stock is not dependent upon the holding period. The value calculated in Parts a

through d is the value for a 3-year holding period. It is equal to the value calculated in Part e. Any

other holding period would produce the same value of RTFDATA ; that is, = $30.00.

10-19 a. Part 1: Gdemo demo demo demo demo demo demo

Supernormal Normalgrowth growth0 demo

| | | | • • • |

D0 D1 (D2 + RTFDATA Obj137 ) D3 D(

demoPVD2

RTFDATA Obj138

demo

D1 = D0≈1 + gs) = $1.80(1.25) = $2.25.

D2 = D0(1 + gs)2 = $1.80(1.25)2 = $2.812.

RTFDATA Obj139 = PV(D1demo demo demo)RTFDATA Obj140

= RTFDATA Obj141

= $2.25/1.08 + $2.812/(1.08)2 + $98.42/(1.08)2 = $88.87.

Financial calculator solution: Input 0, 2.25demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

Part 2: Expected dividend yield:

D1/P0 = $demo demo demo demo.

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Capital gains yield: First, find RTFDATA , which equals the sum of the present values of D2

and discounted for one year.

Financial calculator solution: Input 0, 10demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

Second, find the capital gains yield:

Dividedemo demo demoCapital gains yield = 5.47

8. dem o.

b. Due to the longer period of supernormal growth, the value of the stock will be higher for each year. Although the total return will remain the same, rs = 10%, the distribution between dividend yield and capital gains yield will differ: The dividend yield will start off lower and the capital gains yield will start off higher for the 5-year supernormal growth condition, relative to the 2-year supernormal growth state. The dividend yield will increase and the capital gains yield will decline over the 5-year period until dividend yield = 4% and capital gains yield = 6%.

c. Throughout the supernormal growth period, the total yield, rs, will be 10%, but the dividend yield is relatively low during the early years of the supernormal growth perdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

d. Some investors need cash dividends (retired people), while others would prefer growth. Also, investors must pay taxes each year on the dividends received during the year, while taxes on the capital gain can be delayed until the gain is actually realized. Currently (2008), dividends to individuals are now taxed at the lower capital gains rate of 15%.

demo0 1 2 3 4 5

| |demo

10,000,000 16,000,000 20,000,000 25,000,000 26,500,000

PV = ? demo demo

Using your financial calculator, enter the following inputs: CF0 = 0; CF1 =10000000; CF2 = 16000000; CF3 = 20demo demo demo demo demo demo demo demo demo;I/YR = 12.5; and then solve for NPV = $305,705,180.96.

Total firdemo demo demo demoMarket value of debt 65,000,000 (given in problem)Market valudemo demo demo demo

Qian Hu’s expected cdemo demo demo demo demo demo demo demo

10-21 demo demodemo

3,000,000 6,0demo demo demo demo demo

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Using a financial calculator, enter the following inputs: demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

b. The firm’s termdemo demo demo demo demo demo demo

RTFDATA Obj143

c. The firm’s totdemo demo demo demo demo demo

0 1demo| |demo

3,000,000 6,000,demo demo demo demo demo demo demo

PV = ? demo demoRTFDATA Obj144

Using your financial calculator, enter the following inputs: CF0 = demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

d. To find Barrett’s stock price, you need to first find the value ofdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

Total firdemo demo demo demoMarket value, debt + demo demo demo demo demo demo demo demo)Market valudemo demo demo demo

Barrett’s pricdemo demo demo demo demo

RTFDATA Obj145

10-22 FCF = EBIdemo demo demo demo demo dRTFDATA Obj146 emoRTFDATA Obj147

= $500,000,000 demo demo demo demo demo demo= $4demo demo.

Firm value = RTFDATA Obj148

= RTFDATA Obj149

RTFDATA Obj150

= $10,000,000,000.

This is the total firm value. Now find the market value of its equity.

MVTotal demo demo demo$10,000,000,000 = MVEquity + $3,000,000,000

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MVEquity = $7,000,000,000.

This is the market value of all the equity. Didemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

10-23 a. End of Year: 08 09 10 11 12 13 14| | | | | | |

D0 = 1.7demo demo demo

Dt = D0(1 + g)t.

D2009 = $1.75(1.15)1 = $2.01.

D2010 = $1.75(1demo demo demo demo demo demo.

D2011 = $1.75(1.15)3 = $1.75(1.5209) = $2.66.

D2012 = $1.75(1.15)4 = $1.75(1.7490) = $3.06.

D2013 = $1.75(1demo demo demo demo demo demo.

b. Step 1:

PV of demo demo.RTFDATA Obj151

PV D2009 = $2.01/(1.12) = $1.79PV D2010 =demo demo demo demoPV D2011 = $2.66/(1.12)3 = $1.89PV D2012 =demo demo demo demoPV D2013 = $3.52/(1.12)5 = $2.00PV of ddemo demo demo

Step 2:.RTFDATA Obj152

This is the price of the stock 5 years from now. The PV of this price, discounted back 5 years, is as follows:

PV of RTFDATA Obj153 = $demo demo demo demo

Step 3:

The price of tdemo demo demo demo demo

RTFDATA Obj154 = PV dividends Years 2009-2013 + PV of RTFDATA Obj155

= $9.46 demo demo demo.

This problem could also be solved by substituting the proper values into the following

equation:.RTFDATA Obj156

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Calculator solution: Input 0, 2.01, 2.31, 2.66, 3.06, 56.32 (3.52 + 52.80) into the cash flow register, input I/YR = 12, PV = ? PV = $39.43.

demoD1/P0 = $2.01/$39.43 = 5.10%Capital gdemo demo demo demoExpected demo demo demo demo

D6/P5 = demo demo demo demoCapital gdemo demo demo demoExpected demo demo demo demo

*We know that rs is 12%, and the didemo demo demo demo demo demo demo demo demo demo demo demo demo demo.

The main pointdemo demo demo demo demo demo

The total yield is demo demo demo demo demo demo demo demo.

The capital gains yield starts relatively highdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

After 12/31/13, the stock will grow at a 5% rate. Thdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

d. People in high-income tax brackets will be more inclined to purchase demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

e. Since the firm’s supernormal and normal growth rates are lower, the dividends and, hence, the present value of the stock price will be lodemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

f. As the required return increases, the price of the stock goes down, but botdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

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Comprehensidemo demo demo demo

Note tdemo demoThe solutions for Parts a through c of this problem are provided at the backdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

10-24 a. 1.demo demo demo demo.

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2. Find the demo demo demo demo.

Recall that the expected dividend yield is equdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.5

3. Find the edemo demo demo demo demo.

The capital gains yield can be calculated by simply subtracting the dividend yield from the total expected return.5

Alternatively, we can recognize that the capital gains yield measures capital appreciation, hence solve for the price idemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

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b. 1. Find the price today.

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Find the exdemo demo demo demo.

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Find the expected capital gains yield.

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c. We used the 5 year supernormal growth scenario for demo demo demo demo demo demo demo demo

demo demo demo demo demo demo demo demo demo demo demo demo demo demo.

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Upon reflection, we see that these calculations were unnecessary because the constant growth

assumption holds that the long-term growth rate is the dividend growth rate and the capital gains yield,

hence we could have simply subtracted the long-run growth rate from the required return to find the

dividend yield.

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The price as estimated by the corporate valuation method differs from the discounted dividends

method because different assumptions are built into the two situations. If we had projected financial

statements, found both dividends and free cash flow from those projected statements, and applied the

two methods, then the prices produced would have been identical. As it stands, though, the two prices

were based on somewhat different assumptions, hence different prices were obtained. Note especially

that in the FCF model we assumed a WACC of 9% versus 10% for the discounted dividend model.

That would obviously tend to raise the price.

Integdemo demo

10-25Ping An Insurance (Group) Company of China Ltd.Stockdemo demo

Robert Su and Carol Tso are senior vice presidents of the Ping An Insurance (Group) Company

of China Ltd. They are codirectors of the company’s pension fund management division, with Su

having responsibility for fixed-income securities (primarily bonds) and Tso being responsible for

equity investments. A major new client, the Synergis Holdings Ltd., has requested that Ping An

Insurance present an investment seminar to their shareholders and directors; and Su and Tso, who

will make the actual presentation, have asked you to help them.

To illustrate the common stock valuation process, Su and Tso have asked you to

analyze the Bau Bademo demo demo demo demo demo demo demo demo demo demo demo

demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo

demo demo demo demo demo demo demo demo demo demo demo.

A. Describe briefly the legal rights and privileges of common stockholders.

Answer: [Show S10-1 and S10-2 here.] The common stockhdemo demo demo demo

demo demo demo demo demo demo demo demo demo demo demo demo demo

demo demo demo demo demo.

1. Ownership implies control. Thus, a firm’s common stockholders have the right to

elect its firm’s directors, who in turn elect the officers who manage the business.

2. Common stockholders often have the right, called the preemptive right, to

purchase any additionaldemo demo demo demo demo demo demo demo

demo demo demo demo demo demo demo demo demo demo demo demo

demo demo demo demo demo demo demo demo demo demo demo demo

demo demo demo demo demo demo demo demo.

B. (1) Write a formula that can be used to value any stock, regardless of its dividend pattern.

Answer: [Show S10-3 through S10-6 here.demo demo demo demo demo demo demo demo

demo demo demo demo demo demo demo

RTFDATA Obj157 = RTFDATA Obj158

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However, some stocks have dividend demo demo demo demo demo demo demo demo demo


B. (2) What is a constant growth stock? How are constant growth stocks valued?

Answer: [Show S10-7 and S10-8 here.] A constant growth stock is one whose dividends

are expected to grow at a constant rate forever. “Constant growthdemo demo demo





demo demo demo demo demo.For a constant growth stock:

D1 = D0(1 + g), D2demo demo demo demo demo demo demo.

With this regular dividend pattern, the general stock valuation model can be simplified to the

following very important equation:

RTFDATA Obj159 demo.RTFDATA Obj160

This is the well-known “Gordon,” or “constant-growth” model for valuing stocks.

Here D1 is the next expected dividend, which is assumed to be paid 1 year from

now, rs is the required rate of return on the stock, and g is the constant growth rate.

B. (3) What are the implications if a company forecasts a constant g

thademo demo demo demo demo demo demo demo demo demo demo demo demo


demo demo demo?

Answer: [Show S10-9 here.] The model is derived mathematically, and the derivation requires that rs > g. If g is greater than rs, the model gives a negative stock price, which is nonsensical. The model simply cannot be used unless (1) rs > g, (2) g is expected to be constant, and (3) g can reasonably be expected to continue indefinitely.

Stocks may have periods of supernormal growth, whdemo demo demo demo


demo demo.

C. Assume that Bau Bau Agency has a beta coefficient of 1.2, that the risk-free rate (the yield on

T-bonds) is 7%, and that the required rate of return on the market is 12%. What is Bau Bau

Agency’s required rate of return?

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Answer: [Show S10-10 here.] Here demo demo demo demo demo demo demo demo demo

demo demo demo demo

rs = rRF + (rM – demo demo demo demo demo demo demo)= 7% + (5demo demo demo demo.

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D. Assume that Bau Bau Agency is a constant growth company whdemo demo


demo demo demo demo demo demo demo demo demo.

(1) What is the firm’sdemo demo demo demo demo demo demo demo demo?

Answer: [Show S10-11 here.] Bau Bau Agency is a constant growth stock, and its dividend

is expecdemo demo demo demo demo demo demo demo demo demo demo demo



demo

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D0 = 2.0demo demo demo

demo...

D. (2) What idemo demo demo demo demo?

Answer: [Show S10-12 here.] We could extend the time line on out forever, find the

value of Bau Bau Agency’s dividends for every year on out into the future,

and then the PV of each dividend discounted at rs = 13%.demo demo demo







demo demo demo demo demo

RTFDATA Obj161 = RTFDATA Obj162 = RTFDATA Obj163 demRTFDATA Obj164 o demo.

D. (3) What is the demo demo demo demo demo demo demo?

Answer: [Show S10-13 here.] After one year, D1 will have been demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo

RTFDATA Obj165 = RTFDATA Obj166 = RTFDATA Obj167 demRTFDATA Obj168 o demo.

D. (4) What are the expected dividend yield, capital gains yield, and total return during the first

year?

Answer: [Show S10-14 here.] The expected dividend yield in any Year N is

Dividedemo demo,RTFDATA Obj169

While the expected capital gains yield is

Capital gains yield = = rs – RTFDATA Obj170 .

Thus, the dividend yield in demo demo demo demo demo demo demo demo demo demo demoTotal return = 13.0%Dividend yield = $2.12/$30.29 = 7.0%

Capital demo demo demo demo

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E. Now assume that the stock is currently selling at $30.29. What is its expected rate

of return?

Answer: The constant growth model can be rearranged to this form:.RTFDATA Obj171

RTFDATA Obj172

Here the current price of the stock is known, and we solve for the expected return. For Bau Bau Agency:

= $2.12/$30.29 + 0.060 = 0.070 + 0.060 = 13%.

F. What would the stock pricdemo demo demo demo demo demo demo demo demo demo

demo?

Answer: [Show S10-15 here.] If Bau Bau Agency’s dividends were not expected to grow at

all, then its dividend stream would be a perpetuity. Perpetuities are valued as

shown below:

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0 1 2 3

2.00 2.00 2.00

demo..

RTFDATA Obj173 demo

RTFDATA Obj174 = D/rs = $2.00/0.13 = $15.38.

Note that if a preferred stdemo demo demo demo demo demo demo demo demo demo demo.

G. Now assume that Bau Bau Agency is expected to experience nonconstant

growth of 30% for the next 3 years, then return to its long-run constant growth

rate of 6%. What is the stock’s value under these conditions? What are its

expected dividend and capital gains yields in Year 1? Year 4?

Answer: [Show S10-16 through S10-18 here.] Bau Bau Agency is no longer a constant

growth stock, so the constant growth model is not applicdemo demo demo demo





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0 1 2 3 4

| demo

2.600 3.380 4.394 4.65764

46.114 RTFDATA = 66.54 =

54demoRTFDATA Obj176

Simply enter $2 and multiply by (1.30) to get D1 = $2.60; multiply that result by 1.3

to get D2 = $3.38, and so forth. Then recognize that after Year 3, Bau Bau Agency

becomes a constant growth stock, and at that point RTFDATA Obj177 can be found using the

constant growth model. RTFDATA Obj178 is the present value as of t = 3 of the

dividends in Year 4 and beyond and is also called the terminal value.

With the cash flows for D1, D2, D3, and RTFDATA Obj179 shown on the time

ldemo demo demo demo demo demo demo demo demo demo demo demo demo


The dividend yield in Yeademo demo demo demo demo demo demo demo

demo demo

Dividend yidemo dRTFDATA Obj180 emo demo demo.

Capital gains demo demo demo demo demo.

During the nonconstant growth period, the dividend yields and capital gains yields

are not constademo demo demo demo demo demo demo demo demo demo demo



demo.

H. Suppose Bau Bau Agency is expected to experience zero growth during the first 3 years ademo demo

demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo


demo demo demo demo demo?

Answer: [Show S10-19 ademo demo demo demo demo demo demo demo demo

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0 demo

| demo

2.00 2.demo demo demo

20.99demo demo

demo

Duridemo demo

Dividend yidemo dRTFDATA Obj181 emo demo demo.

Capital gains ydemo demo demo demo demo demo.

Again, in Year 4 Bau Bau Agency becomes a demo demo demo demo demo demo


I. Finally, assume that Bau Bau Agency’s earnings and dividends are expected to decline

at a consdemo demo demo demo demo demo demo



demo demo demo?

Answer: [Show S10-21 and S10-22 here.] The company is earning something andemo demo



demo demo

RTFDATA Obj182 = RTFDATA Obj183 = RTFDATA Obj184 = RTFDATA Obj185 = RTFDATA

Obj186 = $9.89.Since it is a constant growth stock:

g = Capitademo demo demo demo,

Hence:

Dividend yield = 13.0% – (-6.0%) = 19.0%.

As demo

Dividend yield = RTFDATA Obj187 = 0.190 = 19.0%.

The dividend and capital gains yields are constant over time, but a high (19.0%) dividend yield is needed to

offset the negative capital gains yield.

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J. Suppose Bau Bau Agency embarked on an aggressive expansion that requires additional capital. Management decided to finance the expansion by borrowing $40 million and by halting dividend paymdemo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo demo?

Answer: [Show S10-23 through S10-28 here.]

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0 1 2 3 4

| demo

-5 10 20 21.20

-4.545

15.026

398.197 530 =

416.94 d emo demo demoValue of equity = Total value – Debt

= $416.94 demo demo demo demo.

Price per share = $376.94/10 = $37.69.

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K. Suppose Bau Bau Agency decided to issue preferred stock that would pay an annual

dividend of $5 andemo demo demo demo demo demo demo demo demo demo demo



demo demo demo?

Answer: [Show S10-29 and S10-30 here.]

RTFDATA Obj188 RTFDATA Obj189

= RTFDATA Obj190

demo.

If the preferred has a 20-year maturity its value would be calculated as follows:

Enter in your financial calculatordemo demo demo demo demo demo demo demo


However, to find the value of the perpetual preferred’s dividends after Year 20 we

can enter the following data: N = 20; I/YR = 10; PMT = 5; FV = 0; and then solve

for PV = $42.57. Thus, dividends in Years 21 to infinity account for $50.00 –

$42.57 = $7.43 of the perpetual preferred’s value.

RTFDATA Obj191 RTFDATA Obj192 RTFDATA Obj193 RTFDATA Obj194 RTFDATA Obj195 RTFDATA Obj196 RTFD

ATA Obj197 RTFDATA Obj198 RTFDATA Obj199

Recovery for Word 5.0 http://ref.officerecovery.com/word/?5316wr

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