Comprehensive_Problem_-_Chapter_8

Comprehensive_Problem_-_Chapter_8 - Chapter 8- Mini Case...

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Unformatted text preview: Chapter 8- Mini Case (7th Ed.) 3 Investments Capital Cities ABC, Inc. Bond Par Value Maturity Coupon rate Payment Required rate of return Market Price $1,000 12 8.75% $87.50 $1,314.00 Southwest Bancorp Preferred Stock Market price Dividend Required rate of return $25.50 $2.50 Emerson Electric Common Stock Market price Last Dividend EPS 5 years ago EPS currently Required rate of return a. $36.75 $1.32 Calculate the value of each security based on your required rate of return. Capital Cities ABC, Inc. Bond Value = PV of interest payments + PV of the par value PV of future interest payments PV = PV of payment of Par Value PV = Value of bond = Better/Easier Method Southwest Bancorp Preferred Stock Value = Preferred dividend/Required rat Value of Preferred Stock = $2.50 Emerson Electric Common Stock Value = next dividend/(Required rate of return - growth rate) Growth Rate Just an easy way to determine g PV = FV = N= Pmt. = I= Next dividend = last dividend x (1 + growth rate) Last dividend happened. If you divident which will be what you Next dividend = $1.32 x (1 +.1548%) = $1.32 x 1.1548 = Value = next dividend/(Required rate of return - growth rate) Value of Common Stock = $1.52/(15.00% - 15.48%) = $1.52/(=0 This is a very bad example since the growth rate in eps/divid If the growth rate is 15.48% N= Pmt. = PV = I= FV = This is very ambitious. b. Which investment(s) should you accept? Why? Two ways of determining whether to buy. Compare cost with worth to you. Compare return of investment (%) with your required rate of return (%) Bond Your Value $1,230.56 Preferred Stock $35.71 Common Stock $0.00 You would buy the preferred stock. It ie worth more to you than its cost (market price). c. Emerson expects eps and dividends growth to decrease by 3%. Growth would decrease from 15.48% Then: Next dividend = last dividend x (1 + growth rate) Last dividend happened. If you buy you care about the next divident which will be what you receive. Next dividend = $1.32 x (1 +.1671%) = $1.32 x 1.1671 = Value = next dividend/(Required rate of return - growth rate) Value of Common Stock = $1.4847/(15.00% - 16.71%) = $1.52/(1.671%) = Your Value $58.92 d. What required rates of return would make you indifferent to all three options? Really asking which rate of return would neither make or lose money for e options. Need to determine what is the Yield to Maturity of each investment. Capital Cities ABC, Inc. Bond FV = PV = N= Pmt. = I= $1,000.00 -$1,314.00 12 $87.50 5.17% Southwest Bancorp Preferred Stock Value = Preferred dividend/Required rat Required rate of return = preferred dividend/value Required rate of return = 2.50/25.50 = Emerson Electric Common Stock Value of common stock = next dividend/(Required rate of Re Required rate of return = next dividend/value of stock + grow Rate of return = 19.63% If you invest in each of the three and receive a return (%) equal to your requir you will receive a rate of return neither higher or lower than what you require to whether you invest or not. Actually you would invest if the return equales your required rate of return be the shareholders and creditors happy. The following are not in the Mini Case but provide more examples. c.1 If your required rate of return changed to 12% of the bond, 14% for the prefer and 18% for the common stock, how would your answers change to parts a a Calculate the value of each security based on your new required rate of retur Bond Value = PV of future interest payments PV of future interest payments PV = PV of payment of Par Value PV = Value of bond = Alternative Method Preferred Stock Value = Preferred dividend/Required rat $2.50/0.14 Value of Preferred Stock = Common Stock Value = next dividend/(Required rate of return - growth rate) Growth Rate 15.48% Next dividend = last dividend x (1 + growth rate) $1.52 Value of Common Stock = $60.49 Your Value Bond Preferred Stock Common Stock c.2 $1,068.11 $17.86 $60.49 Assuming again that your required rate of return for the common stock is 20% anticipated constant growth rate changes to 12%, how would your answers to and b change? Common Stock Value = next dividend/(Required rate of return - growth rate) Growth Rate Given as = Next dividend = last dividend x (1 + growth rate) = $2.00 x (1 Value = next dividend/(Required rate of return - growth rate) Value = $1.48/(.2 - .12) = $28.00 Value of Common Stock = Your Value $18.48 years 6.00% 7.00% $1.49 $3.06 15.00% r required rate of return. PV of the par value f future interest payments FV = 0 PV = ? N= 12 Maturity Pmt. = $87.50 Payment I= 6.00% Required rate of return $733.59 f payment of Par Value FV = PV = N= Pmt. = I= $1,000 Par Value ? 12 Maturity 0 6.00% Required rate of return $496.97 e of bond = r/Easier Method FV = PV = N= Pmt. = I= $1,230.56 $1,000.00 ? 12 $87.50 6.00% rred dividend/Required rate of return e of Preferred Stock = $2.50/.07 = ate of return - growth rate) an easy way to determine g. $1.49 $3.06 5 0 15.48% growth rate + growth rate) $1,230.56 (Perpetuity) $35.71 dividend happened. If you buy you care about the next ent which will be what you receive. ) = $1.32 x 1.1548 = $1.5243 ate of return - growth rate) 5.00% - 15.48%) = $1.52/(=0.48%) = Means nothing. he growth rate in eps/dividends is unreasonable. the eps in 20 years would increase (in %) as follows: 20 0 -1 15.48% 17.79 is very ambitious. required rate of return (%) Mkt. Price $1,314.00 don't buy $25.50 value>price buy $36.75 e to you value<price Price>value don't buy rease by 3%. to 12.48% y you care about the next $1.4847 wth rate) %) = $1.52/(1.671%) = Meaningless Mkt. Price $36.75 prive>value don't buy fferent to all three options? r make or lose money for each of the three of each investment. rred dividend/Required rate of return $58.92 dividend/value 9.80% idend/(Required rate of Return- Growth Rate) dend/value of stock + growth rate rn (%) equal to your required rate of return wer than what you require and will be indifferent r required rate of return because it would make xamples. e bond, 14% for the preferred stock, nswers change to parts a and b? r new required rate of return. f future interest payments + PV of payment of Par Value f future interest payments FV = 0 PV = ? N= 12 Maturity Pmt. = $87.50 Payment I= 12.00% Required rate of return $885.41 f payment of Par Value FV = PV = ? N= Pmt. = I= $1,000 Par Value 12 Maturity 0 12.00% Required rate of return $182.70 e of bond = $1,068.11 native Method FV = PV = N= Pmt. = I= $1,000.00 ? 12 $87.50 12.00% $798.68 rred dividend/Required rate of return e of Preferred Stock = ate of return - growth rate) + growth rate) Mkt. Price (Perpetuity) $17.86 $1,314.00 value<cost $25.50 value<cost $36.75 value>cost don't buy don't buy buy or the common stock is 20%, but the how would your answers to parts a ate of return - growth rate) 12.00% + growth rate) = $2.00 x (1 + .12) = $1.48 ate of return - growth rate) e = $1.48/(.2 - .12) = $28.00 e of Common Stock = Mkt. Price $36.75 value<cost $18.48 don't buy Free Cash Flow Model (Table 8-1), page 246 Most accurate way to value common stock many stocks do not pay dividends Can retain and invest with higher return than what is needed to keep the shareholders happy (Ke). Assumptions: Sales last year = $1,000.00 Anticipated sales growth Years 1-2 12.00% per year Years 3-5 8.00% per year Beyond yr. 5 4.00% per year Operating profit margin (OI/Sales) 12.00% = Corporate tax rate = 40.00% Assets/Sales = 45.00% Cost of capital = 12.00% Is required rate of return Number of common shares = 100 Year 1 Sales 1,120.00 Operating Profits 134.40 Taxes 53.76 Profit after Taxes 80.64 - Increase in assets 54.00 Free Cash Flow 26.64 Year 2 1,254.40 150.53 60.21 90.32 60.48 29.84 Year 3 1,354.75 162.57 65.03 97.54 45.16 52.38 Year 4 1,463.13 175.58 70.23 105.35 48.77 56.57 Present value of cash flows for years 1 - 5. Year 5 1,580.18 189.62 75.85 113.77 52.67 61.10 $155.48 Residual value (as beginning of year 6) = cash flow (yr. 6)/(cost of capital - growth rate) = 89.88/(.12 - .04) = 89.88/.08 = 1,123.50 It is better to do on financial calculator because growth rate is rounded off and the most correct answer is actually Present value of residual value REMEMBER: THIS IS THE VALUE AT THE END OF 5 YEARS. YOU HAVE TO DISCOUNT IT TO NOW!!! PV = FV = N= Pmt. = I= PV = ? $637.51 $1,123.51 5 0 12.00% Cost of capital $637.51 Total Firm Value $792.99 Present value of cash flows for years 1 - 5. Present value of residual value Total Value of Firm = Less: Debt Equity Value han what Year 6 1,643.39 197.21 78.88 118.32 28.44 89.88 wth rate is $1,123.51 YEARS. $155.48 $637.51 $792.99 $250.00 $542.99 ...
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