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Unformatted text preview: Corporate Finance: The Core (Berk/DeMarzo) Chapter 9  Valuing Stocks 1) When discounting dividends you should use? A) the weighted average cost of capital. B) the after tax weighted average cost of capital. C) the equity cost of capital. D) the before tax cost of debt. 2) Which of the following statements is false? A) The equity cost of capital for a stock is the expected return of other investments available in the market with equivalent risk to the firm’s shares. B) The price of a share of stock is equal to the present value of the expected future dividends it will pay. Div1 + P C) 1 , it would be a negative NPV investment, and we If the current stock price were less than P0 = 1 + rE would expect investors to rush in and sell it, driving down the stocks price. D) The law of one price implies that to value any security, we must determine the expected cash flows an investor will receive from owning it. 3) Which of the following statements is false? A) We must discount the cash flows from stock based on the equity cost of capital for the stock. B) The divided yield is the percentage return the investor expects to earn from the dividend paid by the stock. C) The firm might pay out cash to its shareholders in the form of a dividend. D) The dividend yield is the expected annual dividend of a stock, divided by its expected future sale price. 4) Which of the following statements is false? A) Future dividend payments and stock prices are not known with certainty; rather these values are based on the investor’s expectations at the time the stock is purchased. B) The capital gain is the difference between the expected sale price and the purchase price of the stock. C) The sum of the dividend yield and the capital gain rate is called the total return of the stock. D) We divide the capital gain by the expected future stock price to calculate the capital gain rate. 5) Which of the following statements is false? A) An investor will be willing to pay up to the point at which the current price of a share of stock equals the present value of the expected future dividends an expected future sale price. B) The expected total return of a stock should equal the expected return of other investments available in the market with equivalent risk. C) The total amount received in dividends and from selling the stock will depend on the investor’s investment horizon. Div1 + P D) 1 , it would be a positive NPV investment, and If the current stock price were greater than P0 = 1 + rE we would expect investors to rush in and buy it, driving up the stocks price. 6) Which of the following formulas is incorrect? P −P A) Capital Gains Rate = 0 1 P0
Div1 B) Dividend Yield = P0 Div1 Div2 + P2 C) + P0 = 1 + rE (1 + rE )2 D) rE = Capital Gains Rate + Dividend Yield 7) Which of the following formulas is incorrect? Div1 Div2 + P2 A) Div N P0 = + + ... + 2 1 + rE (1 + rE ) (1 + rE ) N B) P0 = ∑ N Divn (1 + rE ) n n =1 Div1 + P0 C) rE = P 1 Div1 + P D) 1 P0 = 1 + rE Use the information for the question(s) below. Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of the second year. You expect Von Boraʹs stock price to be $25.00 at the end of two years. Von Boraʹs equity cost of capital is 10% WS1) The price you would be willing to pay today for a share of Von Bora stock, if you plan to hold the stock for two years is closest to: A) $23.15 B) $20.65 C) $21.95 D) $21.90 Answer: A Div1 Explanation: A) Div2 + P2 1.40 1.50 + 25.00 P0 = + = + = $23.17 2 1 + .10 1 + rE (1 + rE ) (1 + .10) 2 B) C) D) 8) Suppose you plan to hold Von Bora stock for one year. The price would would expect to be able to sell a share of Von Bora stock in one year is closest to: A) $26.50 B) $22.70 C) $23.15 D) $24.10 9) Suppose you plan to hold Von Bora stock for only one year. Your capital gain from holding Von Bora stock for the first year is closest to: A) $0.95 B) $1.40 C) $1.85 D) $1.25 10) Suppose you plan to hold Von Bora stock for only one year. Your capital gain rate from holding Von Bora stock for the first year is closest to: A) 3.5% B) 4.0% C) 6.0% D) 4.5% 11) Suppose you plan to hold Von Bora stock for only one year. Your dividend yield from holding Von Bora stock for the first year is closest to: A) 6.0% B) 4.0% C) 6.5% D) 5.5% WS2) Suppose you plan on purchasing Von Bora stock in one year, right after the $1.40 dividend is paid. You then plan on selling your stock at the end of year two, right after the $1.50 dividend is paid. The capital gain rate that you will receive on your investment is closest to: A) 4.00% B) 3.75% C) 6.25% D) 3.50% Answer: B Explanation: A) Div2 + P2 B) 1.50 + 25.00 P1 = = = = $24.10 1 (1 + .10) (1 + rE ) So capital gain rate = (P2  P1) / P1 = ($25.00  $24.10) / $24.10 = .03734 or 3.73% C) D) 12) Suppose you plan on purchasing Von Bora stock in one year, right after the $1.40 dividend is paid. You then plan on selling your stock at the end of year two, right after the $1.50 dividend is paid. The dividend yield that you will receive on your investment is closest to: A) 5.75% B) 6.50% C) 6.25% D) 4.00% 13) Suppose you plan on purchasing Von Bora stock in one year, right after the $1.40 dividend is paid. You then plan on selling your stock at the end of year two, right after the $1.50 dividend is paid. The total return that you will receive on your investment is closest to: A) 9.50% B) 10.75% C) 10.25% D) 10.00% WS3) Suppose you plan to hold Von Bora stock for only one year. Calculate your total return from holding Von Bora stock for the first year. Div2 + P2 Answer: 1.50 + 25.00 P1 = = = $24.10 1 (1 + .10) (1 + rE ) P0 = Div1 Div2 + P2 1.40 1.50 + 25.00 + = + = $23.17 2 1 + .10 1 + rE (1 + rE ) (1 + .10) 2 Capital Gain = P1  P0 = 24.10  23.17 = $0.93 Capital Gain rate = capital gain / P0 = 0.93 / 23.17 = .0401 or 4.0% Dividend yield = Div1 / P0 = $1.40 / 23.17 = .0604 or 6.0% Total return = capital gain rate + dividend yield = 4.0% + 6.0% = 10% 9.2 The DividendDiscount Model 14) Which of the following formulas is incorrect? earningst A) Divt = × Dividend Payout Rate shares outstandingt
DivN B) PN = rE − g C) earnings growth rate = retention rate x return on new investment DivN DivN +1 Div1 Div2 D) 1 P0 = + + ... + + × N N 2 rE − g 1 + rE (1 + rE ) (1 + rE ) (1 + rE ) 15) JRN enterprises just announced that it plans to cut its dividend from $2.50 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRNʹs dividends were expected to grow at 4% per year and JRNʹs stock was trading at $25.00 per share. With the new expansion, JRNʹs dividends are expected to grow at 8% per year indefinitely. Assuming that JRNʹs risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to: A) $25.00 B) $15.00 C) $31.25 D) $27.50 16) You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Beanʹs equity cost of capital is 12%, then the price of a share of Beanʹs stock is closest to: A) $17.00 B) $10.75 C) $27.75 D) $43.50 17) MJ LTD is expected to grow at various rates over the next five years. The company just paid a $1.00 dividend. The company expects to grow at 20% for the next two years (effecting D1 and D2), then the company expects to grow at 10% for three additional years (D3, D4, D5) after which the company expects to grow at a constant rate of 5% per year indefinitely. If the required rate of return on MJʹs common stock is 12%, then what is a share of MJʹs stock worth? a) $20.15 b) $21.00 c) $21.52 d) $21.85 18) Growing Real Fast Company (GRF) is expected to have a 25 percent growth rate for the next four years (effecting D1, D2, D3, and D4). Beginning in year five, the growth rate is expected to drop to 7 percent per year and last indefinitely. If GRF just paid a $2.00 dividend and the appropriate discount rate is 15 percent, then what is the value of a share of GRE? a) $47.24 b) $46.52 c) $48.98 d) $45.45 9.3 Total Payout and Free Cash Flow Valuation Models 19) Which of the following equations is incorrect? V0 + Debt  Cash A) P0 = Shares Outstanding
FCFN VN FCF1 FCF2 B) + + ... + + V0 = 2 N 1 + rwacc (1 + rwacc ) (1 + rwacc ) (1 + rwacc ) N C) Free Cash Flow = EBIT × (1  τc) + Depreciation  Capital Expenditures  DNWC D) Enterprise Value = Market Value of Equity + Debt  Cash 20) The Rufus Corporation has 125 million shares outstanding and analysts expect Rufus to have earnings of $500 million this year. Rufus plans to pay out 40% of its earnings in dividends and they expect to use another 20% of their earnings to repurchase shares. If Rufusʹ equity cost of capital is 15% and Rufusʹ earnings are expected to grow at a rate of 3% per year, then the value of a share of Rufus stock is closest to: A) $13.35 B) $33.50 C) $20.00 D) $16.00 Use the information for the question(s) below. You expect CCM Corporation to generate the following free cash flows over the next five years: Year FCF ($ millions) 1 25 2 28 3 32 4 37 5 40 Following year five, you estimate that CCMʹs free cash flows will grow at 5% per year and that CCMʹs weighted average cost of capital is 13%. 21) The enterprise value of CCM corporation is closest to: A) $396 million B) $290 million C) $382 million D) $350 million 22) If CCM has $150 million of debt and 12 million shares of stock outstanding, then the share price for CCM is closest to: A) $49.50 B) $11.25 C) $20.50 D) $22.75 Use the information for the question(s) below. You expect DM Corporation to generate the following free cash flows over the next five years: Year 1 2 3 4 5 FCF ($ millions) 75 84 96 111 120 Beginning with year six, you estimate that DMʹs free cash flows will grow at 6% per year and that DMʹs weighted average cost of capital is 15%. 23) If DM has $500 million of debt and 14 million shares of stock outstanding, then what is the price per share for DM Corporation? a) 37.00 b) 38.00 c) 39.00 d) 40.00 9.4 Valuation Based on Comparable Firms 24) Which of the following statements is false? A) The fact that a firm has an exceptional management team, has developed an efficient manufacturing process, or has just secured a patient on a new technology is ignored when we apply a valuation multiple. B) Valuation multiples have the advantage that they allow us to incorporate specific information about the firm’s cost of capital or future growth. C) For firms with substantial tangible assets, the ratio of price to book value of equity per share is sometimes used. D) Using multiples will not help us determine if an entire industry is overvalued. Use the information for the question(s) below. Suppose that Texas Trucking (TT) has earnings per share of $3.45 and EBITDA of $45 million. TT also has 5 million shares outstanding and debt o $150 million (net of cash). You believe that Oklahoma Logistics and Transport (OLT) is comparable to TT in terms of its underlying business, but OLT has no debt. OLT has a P/E of 12.5 and an enterprise value to EBITDA multiple of 7. 25) Based upon the price earnings multiple, the value of a share of Texas Trucking is closest to: A) $49.30 B) $43.10 C) $24.15 D) $27.60 B ased upon the enterprise value to EBITDA ratio, the value of a share of Texas Trucking is closest to: 1 1 ) A) $33.00 B) $82.50 C) $43.10 D) $21.25 ...
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 Spring '09
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