# PQ1_A - though this smoothing effect cannot have a large...

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FINA573 Equity Valuation Solutions to Practice 1 Questions Question 1 A. False. The reverse is generally true. B. True. The value of an asset is an increasing function of its cash flows. C. True. The value of an asset is an increasing function of its life. D. False. Generally, the greater the uncertainty, the lower is the value of an asset. E. False. The present value effect will translate the value of an asset from infinite to finite terms. Question 2 A. A stock that pays no dividends is not a stable stock. The Gordon Growth model is not designed to value such a stock. B. A stable stock cannot have a growth rate greater than the discount rate, because no company can grow much faster than the economy in which it operates in the Gordon Growth Model. This upper limit on how high growth rates can go operates as a constraint in the model. C. This should not happen for a stable stock, for the same reasons stated above. D. It is true that the model smoothes out growth rates in dividends. In present value terms,

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Unformatted text preview: though, this smoothing effect cannot have a large effect on the value estimate obtained from the model. E. The model requires that, in the long term, the growth rate for a firm is stable (close to the growth rate in the economy). Thus, cyclical firms, which maintain an average growth rate close to a stable rate, cyclical ups and downs notwithstanding, can be valued using this model. Question 3 A. Value Per Share = \$3.56 * 1.055/(.1120 - .055) = \$65.89 B. \$3.56 (1 + g)/(.1120 - g) = \$80 Solving for g, g = (80 * .112 - 3.56)/(80 + 3.56) = 6.46% Question 4: D 5 = 1.25x 60% = \$0.75; g=40%x15%=6%; r=12%; I=\$6million; million I r g r D V 94 . 1 \$ ) 1 ( 4 5 = − + − = Since the value of the firm as a going concern is less than its salvage value of \$3million, the family should shut down the business . Question 5: 08 . 5 \$ ) 1 ( ) ( ) 1 ( 4 5 4 4 = + − + + = r g r D r D P...
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PQ1_A - though this smoothing effect cannot have a large...

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