Exercises

1. Exercises Chapter 11 Valuation

2. Exercise - 1 A major retailer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 8 years remaining until maturity. The bonds were issued with a 6.5 percent coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 4.25 percent.

3. Exercise - 2 What will be the value of these securities in one year if the required return is 7 percent?

4. Exercise - 3 A major manufacturer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 7 years remaining till maturity. The bonds were issued with an 8 percent coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 10 percent.

5. Exercise - 4 What will be the value of these securities in one year if the required return is 6 percent?

6. Exercise - 5 A large grocery chain is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 6 years remaining until maturity. The bonds were issued with a 6 percent coupon rate (paid semiannually) and a par value of $1,000. Because of increased risk the required rate has risen to 10 percent.

7. Solution You can also refer the Present value tables P = 30(PVIFA5%,12) + 1000(PVIF5%,12) P = 30(8.8633) + 1000(.5568) = $822.70

8. Exercise - 6 In 2004, Montpelier Inc. issued a $100 par value preferred stock that pays a 9 percent annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring a 10 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?

9. Solution Dividend = .09 * $100 = $9 As we know P = D/Kp Therefore Price = 9/0.1 = $90

10. Exercise - 7 In 2004, Smiths Corp. issued a $50 par value preferred stock that pays a 6 percent annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring an 7 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?

11. Exercise - 8 Using the constant growth model, a decrease in the required rate of return from 15 to 13 percent combined with an increase in the growth rate from 5 to 6 percent would cause the price to A. Rise more than 50%. B. Rise less than 50%. C. Remain constant. D. Fall more than 50%. E. Fall less than 50%.

12. Solution %D = P2/P1 = [(D0)(1 + g2)/(k2 - g2)]/[(D0)(1 + g1)/(k1 - g1)] � 1 = [(D0)(1 + 0.06)/(0.13 - 0.06)]/[(D0)(1 + 0.05)/(0.15 - 0.05)] � 1 = (15.14 � 10.5) - 1 = 44.22% < 50%

13. Exercise - 9 Using the constant growth model, an increase in the required rate of return from 19 to 17 percent combined with an increase in the growth rate from 11 to 9 percent would cause the price to A. Fall more than 2% B. Fall less than 2%. C. Remain constant. D. Rise more than 2%. E. Rise less than 3%.

14. Solution %D = P2/P1 = [(D0)(1 + g2)/(k2 - g2)]/[(D0)(1 + g1)/(k1 - g1)] � 1 = [(D0)(1 + 0.09)/(0.17 - 0.09)]/[(D0)(1 + 0.11)/(0.19 - 0.11)] � 1 = (13.625 /13.875) - 1 = -1.8% > -2%

15. Exercise - 10 Davenport Corporation's last dividend was $2.70 and the directors expect to maintain the historic 3 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 5 percent for the next three years and the stock will then reach $25 per share.

16. Exercise - 10 How much should you be willing to pay for the stock if you require a 17 percent return? N-Period Model How much should you be willing to pay for the stock if you feel that the 5 percent growth rate can be maintained indefinitely and you require a 17 percent return? Infinity Period Model

17. Solution (infinity Period) P = [(2.70*(1+.05)]/(0.17 - 0.05) = $23.63 P = (2.70*1.05)/(0.17 - 0.05) = $23.63

18. Exercise - 11 Ross Corporation paid dividends per share of $1.20 at the end of 1990. At the end of 2000 it paid dividends per share of $3.50. Calculate the compound annual growth rate in dividends. g = (3.50/1.20)1/10 - 1 = 11.29%

19. Exercise - 12 Hunter Corporation had a dividend payout ratio of 63% in 1999. The retention rate in 1999 was retention rate = 1 - .63 = 37%

20. Exercise - 13 The beta for the DAK Corporation is 1.25. If the yield on 30 year T-bonds is 5.65%, and the long term average return on the S&P 500 is 11%. Calculate the required rate of return for DAK Corporation. required return = .0565 + 1.25(.11 - .0565) = 12.34%

21. Exercise - 14 Micro Corp. just paid dividends of $2 per share. Assume that over the next three years dividends will grow as follows, 5% next year, 15% in year two, and 25% in year 3. After that growth is expected to level off to a constant growth rate of 10% per year. The required rate of return is 15%. Calculate the intrinsic value using the multistage model.

22. Exercise - 15 The P/E ratio for BMI Corporation 21, and the P/S ratio is 5.2. The industry P/E ratio is 35 and the industry P/S ratio is 7.5. Based on relative valuation, BMI is Relative P/E = 21/35 = undervalued Relative P/S = 5.2/7.5 = undervalued

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