bkmsol_ch18 - CHAPTER 18 EQUITY VALUATION MODELS 1 2 3...

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CHAPTER 18: EQUITY VALUATION MODELS 1. Choice (a): P 0 = D 1 /(k – g) = $2.10/(0.11 – 0) = $19.09 2. (c) 3. a.k = D 1 /P 0 + g 0.16 = $2/$50 + g g = 0.12 = 12% b. P 0 = D 1 /(k – g) = $2/(0.16 – 0.05) = $18.18 The price falls in response to the more pessimistic dividend forecast. The forecast for current year earnings, however, is unchanged. Therefore, the P/E ratio falls. The lower P/E ratio is evidence of the diminished optimism concerning the firm's growth prospects. 4. a.g = ROE × b = 16% × 0.5 = 8% D 1 = $2(1 – b) = $2(1 – 0.5) = $1 P 0 = D 1 /(k – g) = $1/(0.12 – 0.08) = $25 b. P 3 = P 0 (1 + g) 3 = $25(1.08) 3 = $31.49 5. a.This director is confused. In the context of the constant growth model [i.e., P 0 = D 1 /( k g )], 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 increases the dividend payout rate, the growth rate g will fall, and stock price will not necessarily rise. In fact, if ROE > k , price will fall. b. (i) An increase in dividend payout will reduce the sustainable growth rate as less funds are reinvested in the firm. The sustainable growth rate (i.e., ROE × plowback) will fall as plowback ratio falls. (ii) The increased dividend payout rate will reduce the growth rate of book value for the same reason -- less funds are reinvested in the firm. 6. a.k = r f + β[Ε (r M ) – r f ] = 6% + 1.25(14% – 6%) = 16% 18-1
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g = 2/3 × 9% = 6% D 1 = E 0 (1 + g) (1 – b) = $3(1.06) (1/3) = $1.06 60 . 10 $ 10 . 0 16 . 0 06 . 1 $ g k D P 1 0 = - = - = b. Leading P 0 /E 1 = $10.60/$3.18 = 3.33 Trailing P 0 /E 0 = $10.60/$3.00 = 3.53 c. 275 . 9 $ 16 . 0 18 . 3 $ 60 . 10 $ k E P PVGO 1 0 - = - = - = The low P/E ratios and negative PVGO are due to a poor ROE (9%) that is less than the market capitalization rate (16%). d. Now, you revise b to 1/3, g to 1/3 × 9% = 3%, and D 1 to: E 0 × 1.03 × (2/3) = $2.06 Thus: V 0 = $2.06/(0.16 – 0.03) = $15.85 V 0 increases because the firm pays out more earnings instead of reinvesting a poor ROE. This information is not yet known to the rest of the market. 7. Since beta = 1.0, then k = market return = 15% Therefore: 15% = D 1 /P 0 + g = 4% + g g = 11% 8. a. 160 $ 05 . 0 10 . 0 8 $ g k D P 1 0 = - = - = b. The dividend payout ratio is 8/12 = 2/3, so the plowback ratio is b = 1/3. The implied value of ROE on future investments is found by solving: g = b × ROE with g = 5% and b = 1/3 ROE = 15% c. Assuming ROE = k, price is equal to: 120 $ 10 . 0 12 $ k E P 1 0 = = = Therefore, the market is paying $40 per share ($160 – $120) for growth opportunities. 18-2
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9. Using a two-stage dividend discount model, the current value of a share of Sundanci is calculated as follows. 2
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bkmsol_ch18 - CHAPTER 18 EQUITY VALUATION MODELS 1 2 3...

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