{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

ch_13_sol - CHAPTER 13 EQUITY VALUATION 1 2 3(a P = 2.10.11...

Info icon This preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
CHAPTER 13: EQUITY VALUATION 1. (a) P = 2.10/.11 = 19.09 2. (c) 3. a. k = D 1 /P 0 + g .16 = 2/50 + g g = .12 b. P 0 = D 1 /(k – g) = 2/(.16 – .05) = 18.18 The price falls in response to the more pessimistic dividend forecast. The forecast for current earnings, however, is unchanged. Therefore, the P/E ratio must fall. 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 will depend on a comparison of the expected rate of return on reinvested earnings versus 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. 5. a. g = ROE × b = 20% × .30 = 6% D 1 = $2(1 – b) = $2(1 – .30) = $1.40 P 0 = D 1 /(k – g) = $1.40/(.12 – .06) = $23.33 P/E = 23.33/2 = 11.67 b. PVGO = P 0 = 23.33 – = $6.67 c. g = ROE × b = 20% × .20 = 4% D 1 = $2(1 – b) = $2(1 – .20) = $1.60 P 0 = D 1 /(k – g) = $1.60/(.12 – .04) = $20 P/E = 20/2 = 10 PVGO = P 0 = 20 – = $3.33 13-1
Image of page 1

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

View Full Document Right Arrow Icon
6. a. g = ROE × b = 16% × .5 = 8% D 1 = $2(1 – b) = $2.00 × (1 – .5) = $1.00 P 0 = D 1 /(k – g) = $1/(.12 – .08) = $25 b. P 3 = P 0 (1 + g) 3 = $24(1.08) 3 = $31.49 7. a. E(r) = k = + g = + .08 = .11 = 11% b. The model assumes that the dividend growth rate is forever constant. Therefore, the model cannot be applied to firms that currently do not pay dividends. Second, the model is inappropriate when g > k (which presumably cannot persist indefinitely). Third, the model cannot handle firms with variable dividend growth paths. c. One can use either P/E multiples or market-to-book multiples exhibited by other firms in the same industry.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern