{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Solutions to Valuation Questions

Solutions to Valuation Questions - Solutions to Valuation...

Info icon This preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Solutions to Valuation Questions 1. Assume you expect a company’s net income to remain stable at $1,100 for all future years, and you expect all earnings to be distributed to stockholders at the end of each year, so that common equity also remains stable for all future years (assumes clean surplus). Also, assume the company’s β = 1.5, the market risk premium is 4% and the 20-30 year yield on risk free treasury bonds is 5%. Finally, assume the company has 1,000 shares of common stock outstanding. a. Use the CAPM to estimate the company’s equity cost of capital. r e = RF + β * (RM – RF) = 0.05 + 1.5 * 0.04 = 11% b. Compute the expected net distributions to stockholders for each future year. D = NI – Δ CE = $1,100 – 0 = $1,100 c. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company’s current stock price. P e = D / r e = $1,100 / 0.11 = $10,000 price per share = $10,000 / 1,000 = $10 2. Same facts as in (1) above, but assume you expect the company’s income to be $1,100 in the coming year and to grow at the rate of 5% in every subsequent year into infinity. Also, assume that the company’s common equity as of the end of the most recent fiscal year is $8,000, and the investment needed to support the growth in net income causes common equity to increase by 5% each year. Assume the company is an all-equity firm; i.e., all financing comes from stockholders and none comes for debtholders. In this case, the company’s balance sheet has net operating assets (NOA) of $8,000, common equity (CE) of $8,000, and zero net financial obligations (NFO). a. Compute D 1 for the coming year and the rate of growth in D t for every year thereafter. D 1 = NI 1 Δ CE 1 = 1,100 – 0.05 * 8,000 = 700 D 2 = NI 2 Δ CE 2 = (1,100 * 1.05) – 0.05 * (1.05 * 8,000) = 1.05 * (1,100 – 0.05 * 8,000) = 735 = 700 * (1 + 0.05) D 3 = NI 3 Δ CE 3 = (1,100 * 1.05 2 ) – 0.05 * (1.05 2 * 8,000) = 771.75 = 735 * (1 + 1.05) so D is 700 in year 1 and grows at 5% per year thereafter.
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
b. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company’s current stock price.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern