B dividends are expected to grow at 8 annually for 3

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: ock value—Variable growth Lawrence Industries’ most recent annual dividend was $1.80 per share (D0 $1.80), and the firm’s required return is 11%. Find the market value of Lawrence’s shares when: a. Dividends are expected to grow at 8% annually for 3 years, followed by a 5% constant annual growth rate in years 4 to infinity. b. Dividends are expected to grow at 8% annually for 3 years, followed by a 0% constant annual growth rate in years 4 to infinity. c. Dividends are expected to grow at 8% annually for 3 years, followed by a 10% constant annual growth rate in years 4 to infinity. LG4 7–15 Common stock value—All growth models You are evaluating the potential purchase of a small business currently generating $42,500 of after-tax cash flow (D0 $42,500). On the basis of a review of similar-risk investment opportunities, you must earn an 18% rate of return on the proposed purchase. Because you are relatively uncertain about future cash flows, you decide to estimate the firm’s value using several possible assumptions about the growth rate of cash flows. a. What is the firm’s value if cash flows are expected to grow at an annual rate of 0% from now to infinity? b. What is the firm’s value if cash flows are expected to grow at a constant annual rate of 7% from now to infinity? c. What is the firm’s value if cash flows are expected to grow at an annual rate of 12% for the first 2 years, followed by a constant annual rate of 7% from year 3 to infinity? CHAPTER 7 LG5 7–16 Stock Valuation 345 Free cash flow valuation Nabor Industries is considering going public but is unsure of a fair offering price for the company. Before hiring an investment banker to assist in making the public offering, managers at Nabor have decided to make their own estimate of the firm’s common stock value. The firm’s CFO has gathered data for performing the valuation using the free cash flow valuation model. The firm’s weighted average cost of capital is 11%, and it has $1,500,000 of debt at market value and $400,000 of preferred stock at its assumed market value. The estimated free cash flows over the next 5 years, 2004 through 2008, are given below. Beyond 2008 to infinity, the firm expects its free cash flow to grow by 3% annually. Year (t) Free cash flow (FCFt) 2004 $200,000 2005 250,000 2006 310,000 2007 350,000 2008 390,000 a. Estimate the value of Nabor Industries’ entire company by using the free cash flow valuation model. b. Use your finding in part a, along with the data provided above, to find Nabor Industries’ common stock value. c. If the firm plans to issue 200,000 shares of common sock, what is its estimated value per share? LG5 7–17 Using the free cash flow valuation model to price an IPO Assume that you have an opportunity to buy the stock of CoolTech, Inc., an IPO being offered for $12.50 per share. Although you are very much interested in owning the company, you are concerned about whether it is fairly priced. In order to determine the value of the shares, you have decided to apply the free cash flow valuation model to the firm’s financial data that you’ve developed from a variety of data sources. The key values you have compiled are summarized in the...
View Full Document

This document was uploaded on 01/19/2014.

Ask a homework question - tutors are online