BKM_Sol_Ch_13 - Chapter 13 - Equity Valuation Chapter 13...

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Unformatted text preview: Chapter 13 - Equity Valuation Chapter 13 Equity Valuation 1. P = $2.10/0.11 = $19.09 2. (a) and (b) 3. a. g k D P 1- = g 16 . 2 $ 50 $- = % 12 12 . 50 $ 2 $ 16 . g = =- = b. 18 . 18 $ 05 . 16 . 2 $ g k D P 1 =- =- = The price falls in response to the more pessimistic forecast of dividend growth. The forecast for current earnings, however, is unchanged. Therefore, the P/E ratio decreases. The lower P/E ratio is evidence of the diminished optimism concerning the firm's growth prospects. 4. a. False. Higher beta means that the risk of the firm is higher and the discount rate applied to value cash flows is higher. For any expected path of earnings and cash flows, the present value of the cash flows, and therefore, the price of the firm will be lower when risk is higher. Thus the ratio of price to earnings will be lower. b. True. Higher ROE means more valuable growth opportunities. c. Uncertain. The answer depends on a comparison of the expected rate of return on reinvested earnings with the market capitalization rate. If the expected rate of return on the firm's projects is higher than the market capitalization rate, then P/E will increase as the plowback ratio increases. 13-1 Chapter 13 - Equity Valuation 5. a. g = ROE b = 0.20 0.30 = 0.06 = 6.0% D 1 = $2(1 b) = $2(1 0.30) = $1.40 33 . 23 $ 06 . 12 . 40 . 1 $ g k D P 1 =- =- = P/E = $23.33/$2 = 11.67 b. PVGO = P k E = $23.33 66 . 6 $ 12 . 00 . 2 $ = c. g = ROE b = 0.20 0.20 = = 0.04 = 4.0% D 1 = $2(1 b) = $2(1 0.20) = $1.60 00 . 20 $ 04 . 12 . 60 . 1 $ g k D P 1 =- =- = P/E = $20/$2 = 10.0 PVGO = P k E = $20.00 12 . 00 . 2 $ = $3.33 6. a. g = ROE b = 0.16 0.5 = 0.08 = 8.0% D 1 = $2(1 b) = $2(1 0.50) = $1.00 00 . 25 $ 08 . 12 . 00 . 1 $ g k D P 1 =- =- = b. P 3 = P (1 + g) 3 = $25(1.08) 3 = $31.49 7. a. This director is confused. In the context of the constant growth model, it is true that price is higher when dividends are higher holding everything else (including dividend growth) constant . But everything else will not be constant. If the firm raises the dividend payout rate, then the growth rate ( g ) will fall, and stock price will not necessarily rise. In fact, if ROE > k , price will fall. 13-2 Chapter 13 - Equity Valuation b. i. An increase in dividend payout reduces the sustainable growth rate as less funds are reinvested in the firm. ii. The sustainable growth rate is (ROE plowback), which falls as the plowback ratio falls. The increased dividend payout rate reduces the growth rate of book value for the same reason -- less funds are reinvested in the firm. 8. a. k = r f + (k M r f ) = 6% + 1.25(14% 6%) = 16% g = (2/3) 9% = 6% D 1 = E (1 + g) (1 b) = $3 1.06 (1/3) = $1.06 60 . 10 $ 06 . 16 ....
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BKM_Sol_Ch_13 - Chapter 13 - Equity Valuation Chapter 13...

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