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Chapter5 - Chapter 5 Basic Stock Valuation ANSWERS TO...

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Chapter 5 Basic Stock Valuation ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS 5-1 See the model or the printout of the model provided at the end of this set of answers. There we show how to find the stock price under some assumed conditions. 5-2 Again, see the model or the model printout. We show some alternative conditions, or scenarios, and the stock price under those scenarios. 5-3 Again, see the model or the model printout. We show how to use Excel to find the stock price under conditions of nonconstant growth. Note, though, that we do assume constant growth after some number of years. 5-4 Again, see the model or the model printout. Everything up to this point could be found fairly easily with a calculator, but it would be difficult to get an exact solution to Question 4 with a calculator. In the model, we show how to use Excel Goal Seek function to find the expected rate of return. 5-5 Dividend growth models are most appropriate for large, stable, companies that pay dividends and are expected to grow at a relatively constant rate. They can also be applied to companies that pay dividends, or that are expected to pay dividends in the forecastable future, but here the analysis becomes more speculative. Mechanically, it is easy to deal with virtually any situation using Excel, but remember the old saying, GIGO, or Garbage In, Garbage Out. It is especially difficult to justify using the discounted dividend model for tech stock IPOs, where the company is not likely to ever pay a dividend because if it is successful it is likely to be acquired in a merger. The acquisition price, if it could be estimated, and if the timing of the acquisition could be forecasted, could be treated like a dividend, but this is really stretching things. For companies where the discounted dividend model is inappropriate, the corporate valuation model as discussed in Chapter 11 is our choice for valuation purposes. Security analysts are using this model increasingly. 5-6 The three forms of the EMH are weak form, semi-strong form, and strong form. Weak form says efficiency only applies to looking at past stock prices, but other types of analysis might be valid. Semi-strong EMH adds that fundamental analysis is also useless, because stock prices reflect all published data. Strong form says that all information possessed by anyone, including corporate insiders, is reflected in prices, so even insiders trading on inside information cannot make an abnormal profit. Technical trading rules would be ineffective under all three forms—if the EMH is correct in any of its forms, technical analysis is just a waste of time. Most academicians Answers and Solutions: 5 - 1
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who have researched the EMH agree with this proposition, though many technical analysts still exist and earn high salaries on Wall Street.
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