Chapter 6 Assets Valuation - Equity exercise

Chapter 6 Assets Valuation – Equity

1. The DDM Corporation has just paid a cash dividend (D0) of $2 per share. It has consistently increased its cash dividends in the past by 5% per year, and you expect it to continue to do so. You estimate that the market capitalization rate for this stock should be 13% per year. a. What is your estimate of the intrinsic value of a share (derived using the DDM model)?

b. Suppose that the actual price of a share is $20. By how much would you have to adjust each of the following model parameters to “justify” this observed price:

i. The growth rate of dividends ii. The market capitalization rate

2. The Constant Growth Corporation (CGC) has expected earnings per share (E1) of $5. It has a history of paying cash dividends equal to 20% of earnings. The market capitalization rate for CGC’s stock is 15% per year, and the expected ROE on the firm’s future investments is 17% per year? Using the constant growth rate discounted dividend model, a. What is the expected growth rate of dividends?

b. What is the model’s estimate of the present value of the stock? c. If the model is right, what is the expected price of a share a year from now?

d. Suppose that the current price of a share is $50.

By how much would you have to adjust each of the following model parameters to “justify” this observed price:

i. The expected ROE on the firm’s future investments. ii. The market capitalization rate iii. The dividend payout ratio.

3. The Amazing.com Corporation currently pays no cash dividends, and it is not expected to for the next 5 years. Its sales have been growing at 25% per year.

a. Can you apply the constant growth rate DDM to estimate its intrinsic value? Explain.

b. It is expected to pay its first cash dividend $1 per share 5 years from now. It its market capitalization rate is 20% and its dividends are expected to grow by 10% per year, what would you estimate its intrinsic value to be?

c. If its current market price is $100 per share, what would you infer the expected growth rate of its future dividends to be?

4. If the stock is actually trading at $ 45, estimate the growth rate the market expects in Con Ed’s dividends.

5. You are valuing First Bank, a large commercial bank. The bank reported earnings per share of $ 4 last year, and paid out dividends of

$2.40 per share. The earnings are expected to grow 4% a year in perpetuity, and the firm is expected to maintain its existing payout ratio. The firm’s cost of equity is 9%.

a. Estimate the value of equity per share.

b. If the stock is trading at $ 42 per share, estimate the implied growth rate (the growth rate that the market is assuming for this stock).

6. You are valuing Safeco Insurance, a firm that reported earnings per share of $ 5.00 in the most recent financial year and dividends per share of $ 1.00. The earnings per share are expected to grow 16% a year for the next 5 years and 5% thereafter. While the firm will maintain its existing payout ratio for the next 5 years, the payout ratio is expected to increase to 60% thereafter. If the cost of equity for this firm is 12%, estimate the value per share.

7. The annual earnings of Avalanche Skis, Inc., will be $7 per share in perpetuity if the firm makes no new investments. Under such a situation, the firm would pay out all of its earnings as dividends. Assume the first dividend will be received exactly one year from now.

Alternatively, assume that three years form now, and in every

subsequent year in perpetuity, the company can invest 30% of its earnings in new projects. Each project will earn 20% at year-end in perpetuity. The firm’s discount rate is 11%.

a. What is the price per of Avalanche Skis, Inc., stock today without the company making the new investment?

b. If a Avalanche announces that the new investment will be made, what will the per share stock price be today?