Solutions to Practice Problems _Class of Nov 10

# Solutions to Practice Problems _Class of Nov 10 - Class of...

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Class of Nov 10 – Tutorial of Nov 11 SOLUTIONS TO END OF CHAPTER PRACTICE PROBLEMS CHAPTER 15 SECURITY ANALYSIS 1. P 0 = D 1 /(k – g) = \$2.10/(0.11 – 0) = \$19.09 2. I and II 3. a. k = D 1 /P 0 + g .16 = 2/50 + g g = .12 = 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 year 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. 6. a. k = 6 + 1.25(14 – 6) = 16%; g = 2/3 × 9% = 6% D 1 = E 0 (1 + g) (1 – b) = 3(1.06) (1/3) = \$1.06 P 0 = = = \$10.60 b. Leading P 0 /E 1 = 10.60/3.18 = 3.33 Trailing P 0 /E 0 = 10.60/3 = 3.53 c. PVGO = P 0 = \$10.60 – = – \$9.275 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 × .09 = .03, and D 1 to [E 0 (1.03) × (2/3)] = \$2.06. Thus, V 0 = \$2.06/

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Solutions to Practice Problems _Class of Nov 10 - Class of...

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