Net Present Value and Question

1. Given the proposed financing plan, describe your approach (qualitatively) to value AirThread. Should Ms. Zhang use WACC, APV or some combination thereof? Explain. (2 points)

11. What is the Cost of Equity? ke = Risk Free Rate + (Beta X Risk Premium of 7.5% points). .03 + (.99 x .075) = 10.43%.

b) What will be the total equity value and equity price per share after the issuance is completed?

Abacus Corp. will pay dividends of $2.25, $2.95 and $3.15 for the next three years. After three years, the firm will grow at a constant rate of 4 percent. If the required rate of return is 14.5 percent, what is the current value of the stock?

-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?

23) Danroy Inc has announced a $5 dividend. If Danroy's last price while trading cum-dividend is $65, what should its first ex-dividend price be (assuming perfect capital markets)?

3. Wasserstein, Perella & Co. established a valuation range of $68-$80 per common share for Interco. Show that this valuation range can follow from the assumptions described in the discounted cash flow analysis section of Exhibit 12. As a member of Interco’s board, which assumptions would you have questioned? Why?

a. What risk-free rate and risk premium did you use to calculate the cost of equity?

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

b. What is Q’s stock worth per share? How does that value depend on the payout ratio and growth rate after year 4?

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?

* Please choose either the CAPM estimate or the DDM estimate for cost of equity based on your answer to Question 3.

3. Calculate the cost of equity capital using the CAPM, assuming a market risk premium of 5%.

Firms often view dividends as a commitment to their stockholders and quite hesitant to reduce an existing dividends. Once established, dividend cuts would adversely affect the firm’s stock price as a negative signal

Storico Co. just paid a dividend of aud 3.5 per share. The company will increase its dividend by 20% next year, and will then reduce its dividend growth rate by 5% per year, until it reaches the industry average of 5% industry average growth, after which the company will keep a constant growth rate forever. If the required return on Storico stock is 13%, what will a share of stock sell for today?