Ch02_solutions

Ch02_solutions - Chapter 2 Discounted Dividend Valuation...

Info iconThis preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 2 – Discounted Dividend Valuation Solutions 1. For AOL Time Warner, the required return is r = R F + β [ E ( R M ) – R F ] = 4.35% + 2.50(8.04%) = 4.35% + 20.10% = 24.45% For J.P. Morgan Chase, the required return is r = R F + β [ E ( R M ) – R F ] = 4.35% + 1.50(8.04%) = 4.35% + 12.06% = 16.41% For Boeing, the required return is r = R F + β [ E ( R M ) – R F ] = 4.35% + 0.80(8.04%) = 4.35% + 6.43% = 10.78% 2. The five-factor APT model is of the form E ( R i ) = Τ -bill rate + (Sensitivity to confidence risk × 2.59%) – (Sensitivity to time horizon risk × 0.66%) – (Sensitivity to inflation risk × 4.32%) + (Sensitivity to business-cycle risk × 1.49%) + (Sensitivity to market- timing risk × 3.61%) For Terra Energy, the required return is r = 4.10% + (0.25 × 2.59%) – (0.30 × 0.66%) – (–0.45 × 4.32%) + (1.60 × 1.49%) + (0.80 × 3.61%) = 4.10% + 0.65% – 0.20% + 1.94% + 2.38% + 2.89% = 11.76% 3. The required return is given by r = R F + β [ E ( R M ) – R F ] = 0.045 + ( 0.2)(0.075) = 4.5% 1.5% = 3.0% Newmont Mining has a required return of 3 percent. When beta is negative, an asset has a CAPM required rate of return that is below the risk-free rate. 4. The equation for the single-period DDM is 11 0 1 DP V r + = + For Stock 1, 36 . 19 $ 10 . 1 00 . 21 30 . 0 0 = + = V For Stock 2, 10 . 1 00 . 32 00 . 30 1 + = D , D 1 = 1.10(30.00) – 32.00 = $1.00 For Stock 3, 1 2.70 92.00 1.12 P + = , P 1 = 92.00(1.12) – 2.70 = $100.34 For Stock 4, r + + = 1 90 . 17 30 . 0 00 . 16 , 0.30 17.90 1 0.1375 13.75% 16.00 r + =− = = 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
5. Using the CAPM, GM’s required rate of return is r = R F + β [ E ( R M ) – R F ] = 5.3% + 0.90(6.00%) = 5.3% + 5.4% = 10.7% Substituting the values into the single-period DDM, we obtain 11 0 1 (1 ) DP V r + = + , or 1 1 2.40 66.00 (1.107) P + = The expected price is P 1 = 66.00(1.107) – 2.40 = 73.06 – 2.40 = $70.66. 6. A. The projected dividend is D 1 = D 0 (1 + g ) = 1.50(1.05) = $1.575. B. r = R F + β [ E ( R M ) – R F ] = 4.5% + 0.85(6.0%) = 4.5% + 5.1% = 9.6% C. V 0 = D 1 /( r g ) = 1.575/(0.096 – 0.05) = 1.575 /0.046 = $34.24 D. The stock price predicted by the Gordon growth model ($34.24) is below the market price of $50. A g > 5 percent is required for the value estimated with the model to be $50. To find the g that would yield a $50 price, we solve 1.50(1 ) 50 0.096 g g + = , which simplifies to 4.8 – 50 g = 1.5 + 1.5 g 51.5 g = 3.3 g = 0.06408, or g = 6.408% To verify that this growth rate results in a value of $50, substitute g = 6.408 percent into the Gordon growth model equation: 0 0 ) 1.50(1.06408) 1.59612 $50.00 0.096 0.06408 0.03192 Dg V rg + == = = −− 7. A. The value of each stock using the Gordon growth model is 83 . 17 $ 03 . 0 535 . 0 07 . 0 10 . 0 ) 07 . 1 ( 50 . 0 = = = Que V 95 . 31 $ 04 . 0 278 . 1 065 . 0 105 . 0 ) 065 . 1 ( 20 . 1 = = = SHS V 48 . 18 $ 05 . 0 924 . 0 05 . 0 10 . 0 ) 05 . 1 ( 88 . 0 = = = True V B. All three stocks are selling at a premium above their DDM estimated values. The percentage premiums are Premium (Que) = (25–17.83)/17.83 = 7.17/17.83 = 40.2% Premium (SHS) = (40–31.95)/31.95 = 8.05/31.95 = 25.2% Premium (True) = (20–18.48)/18.48 = 1.52/18.48 = 8.2% True Corporation is selling for the smallest relative premium over its estimated value found with the Gordon growth model. 8. A. In the Gordon growth model, the expected rate of return is r = D 1 / P 0 + g . AEP r = 2.40/46.17 + 5.0% = 5.20% + 5.0% = 10.2% Consolidated Edison r = 2.20/39.80 + 5.0% = 5.53% + 5.0% = 10.53% Exelon r = 1.69/64.12 + 7.0% = 2.64% + 7.0% = 9.64% Southern Co. r = 1.34/23.25 + 5.5% = 5.76% + 5.5% = 11.26% Dominion Resources r = 2.58/60.13 + 5.5% = 4.29% + 5.5% = 9.79% 2
Background image of page 2
B. With the capital asset pricing model, the required return is r = R F + β [ E ( R M ) – R F ]: AEP r = 5.3% + 0.6(6.0%) = 5.3% + 3.6% = 8.9% Consolidated Edison r = 5.3% + 0.6(6.0%) = 5.3% + 3.6% = 8.9% Exelon r = 5.3% + 0.8(6.0%) = 5.3% + 4.8% = 10.1% Southern Co. r = 5.3% + 0.65(6.0%) = 5.3% + 3.9% = 9.2% Dominion Resources r = 5.3% + 0.65(6.0%) = 5.3% + 3.9% = 9.2% 9. A. Compounded for eight years, 0.585(1 + g ) 8 = 1.46. Solving for g , we get g = 12.11%.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 10

Ch02_solutions - Chapter 2 Discounted Dividend Valuation...

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online