Solutions to Valuation Questions 1. Assume you expect a company’s net income to remain stable at $1,100 for all future years, and you expect all earnings to be distributed to stockholders at the end of each year, so that common equity also remains stable for all future years (assumes clean surplus). Also, assume the company’s β = 1.5, the market risk premium is 4% and the 20-30 year yield on risk free treasury bonds is 5%. Finally, assume the company has 1,000 shares of common stock outstanding. a. Use the CAPM to estimate the company’s equity cost of capital. • re = RF + β * (RM – RF) = 0.05 + 1.5 * 0.04 = 11% b. Compute the expected net distributions to stockholders for each future year. • D = NI – ΔCE = $1,100 – 0 = $1,100 c. Use the …show more content…
b. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company’s current stock price. • Pe = D1/(re – g) = 700 / (0.11 – 0.05) = $11,667 • price per share = $11,667 / 1,000 = $11.67 3. Same facts as (2) above, except the 5% income growth rate (and beginning of year common equity to support it) are only expected for years 2 and 3. Then growth is expected to be zero and all income is expected to be distributed to shareholders for all future years. a. Compute D1, D2, D3, and Dt for all future years. • Keeping in mind that income is $1,100 in year 1, increases by 5% in years 2 and 3, and then remains constant for all future years; and keeping in mind that beginning of year 1 common equity is $8,000, increases by 5% at the beginning of year 2 and at the beginning of year 3, but does not increase at the beginning of year 4 and remains constant from that point forward, you should be able to compute: D1 = $700, D2 = $735, and Dt = 1,212.75 for D3 and all future years. b. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company’s current stock price. Pe = 700/(1+ 0.11) + 735/(1+ 0.11)2 + [1,212.75/0.11]/(1+ 0.11)2 = $10,175.31 and the price per share of common stock = $10,175.31 / 1,000 = $10.18. 4. Same facts as (3) above, except the growth rates are 5% for years 2 and 3 and then 3% perpetually for all future years. a. Compute D1, D2, D3 and the growth in D
d) Calculate the new value per share after the capital structure change. (Hint: use your answers to parts b and c.)
Some applications of dividend discount modeling can be more complex. One method divides the future growth in dividends into three periods, all of which have different growth rates. This is useful when a company’s profits are expected to grow rapidly and then gradually decline to an industry average. The complexities of this model are outside of the scope of this report, and the model can easily be run using tools found online. The assumptions of this calculation as follows. Walmart is no longer in a growth phase, so this calculation assumes that it is at the transitional phase. Because of this, 2007 data is used to initialize the calculation (EPS, dividend, etc.,) and the ‘growth’ period was 3 years. Initial growth of EPS still assumed to be 10.4%. 14 transitional years, as required by the model (total of 17 years for growth and transition is required). All of these assumptions result in a 3 stage DDM
iii. Prepare a basic discounted cash flow analysis; i.e. compute incremental cash flows and a terminal value, and discount them at a weighted average cost of capital. Can you do a multiples-type analysis here as well?
a. What risk-free rate and risk premium did you use to calculate the cost of equity?
• Pe = D1/(re – g) = 700 / (0.11 – 0.05) = $11,667 • price per share = $11,667 / 1,000 = $11.67 3. Same facts as (2) above, except the 5% income growth rate (and beginning of year common equity to support it) are only expected for years 2 and 3. Then growth is expected to be zero and all income is expected to be distributed to shareholders for all future years. a. Compute D1, D2, D3, and Dt for all future years. • Keeping in mind that income is $1,100 in year 1, increases by 5% in years 2 and 3, and then remains constant for all future years; and keeping in mind that beginning of year 1 common equity is $8,000, increases by 5% at the beginning of year 2 and at the beginning of year 3, but does not increase at the beginning of year 4 and remains constant from that point forward, you should be able to compute: D1 = $700, D2 = $735, and Dt = 1,212.75 for D3 and all future years. b. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company’s current stock price. Pe = 700/(1+ 0.11) + 735/(1+ 0.11)2 + [1,212.75/0.11]/(1+ 0.11)2 = $10,175.31 and the price per share of common stock = $10,175.31 / 1,000 = $10.18. 4. Same facts as (3) above, except the growth rates are 5% for years 2 and 3 and then 3% perpetually for all future years. a. Compute D1, D2, D3 and the growth in D for all future years. • Keeping in mind that income is $1,100 in year 1, increases by 5% in years 2
c. Is your estimate of Lex’s cost of equity appropriate as a discount rate for Lex’s total operating cash flows? Why or why not?
SY Telc is approached by Chen Inc. which offers to make RecRobo for $90 per unit or $1,800,000.
Please form groups of four to five students. Each group should analyze three cases provided below and write a short report. The objectives of the project are to help you develop the ability to 1) evaluate situations that have ethical implications, 2) identify the stakeholders and their interests, 3) describe ethical dilemmas and propose solutions, and 4) explain the importance of social responsibility. Each group should submit a written report that should include: 1. A cover page: title, section, and the names of team members (plus student IDs). 2. Case analysis: one page per case (three pages in total), 12 pt font, single-spaced, one-inch margins all around. The report is
The current T.bill rate is 3%. (It was 5% one year ago).The stock is currently selling for $50, down $4 over the last year, and has paid a dividend of $2 during the last year and expects to pay a dividend of $2.50 over the next year. The New York Stock Exchange (NYSE) composite has gone down 8% over the last year, with a dividend yield of 3%. HeavyTech Inc. has a tax rate of 40%. a. What is the expected return on HeavyTech over the next year? b. What would you expect HeavyTech’s price to be one year from today? c. What would you have expected HeavyTech’s stock returns to be over the last year? d. What were the actual returns on HeavyTech over the last year? e. HeavyTech has $100 million in equity and $50 million in debt. It plans to issue $50 million in new equity and retire $50 million in debt. Estimate the new beta. a. Using the CAPM, we compute the expected return as 0.03 + 1.2(0.0792) = 12.5%. We use a T‐bill rate, because the focus is on the short‐term expected return (the next year). For the same reason, we use the market premium over bills. b. The cum‐dividend price, one year from now, would be $50 *(1 + 12.50%) = $56.25. The ex dividend price, assuming that the stock price goes down by the amount of the dividend is $56.25– $2.50 = $53.75. c. Over last year, the expected return would have been 0.05+1.2*0.0792=14.5%.
The standard method of calculating a stock price using the perpetual dividend growth model is done by assessing a company’s dividend one year into the future adding the future expected growth rate. The formula is written as: P0 = D1/(Ke − g), where Ke is the investor required return, D1 is next year’s dividend and g is the expected
| SpannerWorks receives a tax refund in respect of the 2010 income year. Refund per the return for the year ended 31 March 2010 was $3,600 (net of any UOMI).
Q3. Determine the current value of the equity in this company, using each of the following methods:
Under each of the following situations, what is the Investment in Rambis account balance on Herbert’s books on January 1, 2013?