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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
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...
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