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Question;P7?2 Preferred dividends Slater Lamp;Manufacturing has an outstanding issue of preferred;stock with an $80 par value and an 11%;annual dividend.;a. What is the annual dollar dividend? If;it is paid quarterly, how much will be paid;each quarter?;b. If the preferred stock is noncumulative;and the board of directors has passed the;preferred dividend for the last three;quarters, how much must be paid to preferred;stockholders in the current quarter before;dividends are paid to common;stockholders?;c. If the preferred stock is cumulative and;the board of directors has passed the preferred;dividend for the last three quarters, how;much must be paid to preferred;stockholders in the current quarter before;dividends are paid to common stockholders?;P7?8 Common stock value: Constant growth;Use the constant-growth model (Gordon;growth model) to find the value of each;firm shown in the following table.;Firm;/ Dividend expected next;year/Dividend growth rate/Required return;A $1.20 8% 13%;B 4.00 $4.00;5 15;C 0.65 10 14;D 6.00 8 9;E 2.25;8 20;P7?10 Common stock value: Constant growth;The common stock of Denis and Denis;Research, Inc., trades for $60 per share.;Investors expect the company to pay a;$3.90 dividend next year, and they expect;that dividend to grow at a constant rate;forever. If investors require a 10% return;on this stock, what is the dividend growth;rate that they are anticipating?;P7?14 Common stock 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.;P7?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. 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 following table.;Free cash flow;Year (t) FCFt Other data;2016 $ 700,000 Growth rate of FCF;beyond 2019 to infinity 5 2%;2017 800,000 Weighted average cost of capital;5 8%;2018 950,000 Market value of all;debt 5 $2,700,000;2019 1,100,000 Market value of preferred;stock 5 $1,000,000;Number of shares of common;stock outstanding 5 1,100,000;P7?19 Valuation with price/earnings;multiples For each of the firms shown in the following;table, use the data given to estimate its;common stock value employing price/;earnings (P/E) multiples.;Firm Expected EPS Price/earnings multiple;A;$3.00;6.2;B;4.50 10.0;C;1.80;12.6;D;2.40;8.9;E 5.10 15.0;P8?9 Rate of return, standard deviation;and coefficient of variation Mike is searching;for a stock to include in his current stock;portfolio. He is interested in Hi-Tech;Inc., he has been impressed with the;company?s computer products and believes;that Hi-Tech is an innovative market;player. However, Mike realizes that any;time you consider a technology stock, risk;is a major concern. The rule he follows;is to include only securities with a;coefficient of variation of returns below 0.90.;Mike has obtained the following price;information for the period 2012 through;2015. Hi-Tech stock, being growth-oriented;did not pay any dividends during these;4 years.;Stock price;Year Beginning;End;2012 $14.36;$21.55;2013 21.55 64.78;2014;64.78;72.38;2015 72.38;91.80;P8?14 Portfolio analysis You have been;given the expected return data shown in the first;table on three assets?F, G, and H?over the;period 2016?2019.;Expected return;Year Asset F Asset G Asset H;2016 16% 17% 14%;2017 17 16 15;2018 18 15 16;2019 19 14 17;Using these assets, you have isolated the;three investment alternatives shown in the;following table;Alternative Investment;1 100% of asset F;2 50% of asset F and 50%;of asset G;3 50% of asset F and 50%;of asset H;a. Calculate the expected return over the;4-year period for each of the three;alternatives.;b. Calculate the standard deviation of;returns over the 4-year period for each of the;three alternatives.;c. Use your findings in parts a and b to;calculate the coefficient of variation for;each of the three alternatives.;d. On the basis of your findings, which of;the three investment alternatives do you;recommend? Why?;P8?27 Portfolio return and beta Jamie;Peters invested $100,000 to set up the following;portfolio 1 year ago.;Asset;Cost Beta at purchase Yearly income Value today;A;$20,000 0.80 $1,600 $20,000;B;35,000 0.95 1,400 36,000;C;30,000 1.50 ? 34,500;D;15,000 1.25 375 16,500;a. Calculate the portfolio beta on the;basis of the original cost figures.;b. Calculate the percentage return of each;asset in the portfolio for the year.;c. Calculate the percentage return of the;portfolio on the basis of original cost;using income and gains during the year.;d. At the time Jamie made his investments;investors were estimating that the market;return for the coming year would be 10%.;The estimate of the risk-free rate of return;averaged 4% for the coming year. Calculate;an expected rate of return for each stock;on the basis of its beta and the;expectations of market and risk-free returns.;e. On the basis of the actual results;explain how each stock in the portfolio performed;relative to those CAPM-generated;expectations of performance. What;factors could explain these differences?;P9-5 The cost of debt Gronseth Drywall;Systems, Inc., is in discussions with its investment bankers regarding the;issuance of new bonds. The investment banker has informedthe firm that;different maturities will carry different coupon rates and sell at different;prices. The firm must choose among several alternatives. In each case, the bonds;will have a $1,000 par value and flotation costs will be $30 per bond. The company;is taxed at a rate of 40%. Calculate the after-tax cost of financing with;each of the following alternatives.;Alternative Coupon Rate Time;to Maturity (years) Premium or;Discount;A 9% 16;$250;B 7 5 50;C 6 7 par;D 5 10 - 75;P9?7 Cost of preferred stock Taylor Systems;has just issued preferred stock. The stock;has a 12% annual dividend and a $100 par;value and was sold at $97.50 per share.;In addition, flotation costs of $2.50 per;share must be paid.;a. Calculate the cost of the preferred;stock.;b. If the firm sells the preferred stock;with a 10% annual dividend and nets $90.00;after flotation costs, what is its cost?;P9?9 Cost of common stock equity: CAPM;J&M Corporation common stock has a beta;b, of 1.2. The risk-free rate is 6%, and;the market return is 11%.;a. Determine the risk premium on J&M;common stock.;b. Determine the required return that;J&M common stock should provide.;c. Determine J&M?s cost of common stock;equity using the CAPM.;P9?10 Cost of common stock equity Ross;Textiles wishes to measure its cost of common;stock equity. The firm?s stock is currently;selling for $57.50. The firm expects to pay;a $3.40 dividend at the end of the year;(2016). The dividends for the past 5 years;are shown in the following table.;Year;Dividend;2015;$3.10;2014;2.92;2013;2.60;2012;2.30;2011;2.12;After underpricing and flotation costs, the;firm expects to net $52 per share on a;new issue.;a. Determine the growth rate of dividends;from 2011 to 2015.;b. Determine the net proceeds, Nn, that the;firm will actually receive.;c. Using the constant-growth valuation;model, determine the cost of retained earnings, rr.;d. Using the constant-growth valuation;model, determine the cost of new common stock, rn.;P9?17 Calculation of individual costs and;WACC Dillon Labs has asked its financial manager;to measure the cost of each specific type;of capital as well as the weighted average;cost of capital. The weighted average cost;is to be measured by using the following;weights: 40% long-term debt, 10% preferred;stock, and 50% common stock equity;(retained earnings, new common stock, or;both). The firm?s tax rate is 40%.;Debt The firm can sell for $980 a 10-year;$1,000-par-value bond paying annual;interest at a 10% coupon rate. A flotation;cost of 3% of the par value is required;in addition to the discount of $20 per;bond.;Preferred stock Eight percent (annual;dividend) preferred stock having a par;value of $100 can be sold for $65. An;additional fee of $2 per share must be paid;to the underwriters.;Common stock The firm?s common stock is;currently selling for $50 per share.;The dividend expected to be paid at the end;of the coming year (2016) is $4. Its;dividend payments, which have been;approximately 60% of earnings per share in;each of the past 5 years, were as shown in;the following table.;Year;Dividend;2015;$3.75;2014;3.50;2013;3.30;2012;3.15;2011;2.85;It is expected that to attract buyers, new;common stock must be underpriced;$5 per share, and the firm must also pay $3;per share in flotation costs. Dividend;payments are expected to continue at 60% of;earnings. (Assume that rr = rs.);a. Calculate the after-tax cost of debt.;b. Calculate the cost of preferred stock.;c. Calculate the cost of common stock.;d. Calculate the WACC for Dillon Labs.;P10?4 Long-term investment decision;payback method Bill Williams has the opportunity;to invest in project A that costs $9,000;today and promises to pay annual end-ofyear;payments of $2,200, $2,500, $2,500, $2,000;and $1,800 over the next 5 years.;Or, Bill can invest $9,000 in project B;that promises to pay annual end-of-year payments;of $1,500, $1,500, $1,500, $3,500, and;$4,000 over the next 5 years.;a. How long will it take for Bill to recoup;his initial investment in project A?;b. How long will it take for Bill to recoup;his initial investment in project B?;c. Using the payback period, which project;should Bill choose?;d. Do you see any problems with his choice?;P10?10 NPV: Mutually exclusive projects;Hook Industries is considering the replacement of;one of its old drill presses. Three;alternative replacement presses are under consideration.;The relevant cash flows associated with each;are shown in the following table.;The firm?s cost of capital is 15%.;LG 3;LG 2 LG 3;LG 3;Press A Press B Press C;Initial investment (CF0) $85,000 $60,000 $130,000;Year (t) Cash inflows (CFt);1 $18,000 $12,000 $50,000;2 18,000;14,000 30,000;3 18,000 16,000 20,000;4 18,000 18,000 20,000;5 18,000 20,000 20,000;6 18,000 25,000 30,000;7 18,000 ? 40,000;8 18,000 ? 50,000;a. Calculate the net present value (NPV) of;each press.;b. Using NPV, evaluate the acceptability of;each press.;c. Rank the presses from best to worst;using NPV.;d. Calculate the profitability index (PI);for each press.;e. Rank the presses from best to worst;using PI.;P10?11 Long-term investment decision, NPV;method Jenny Jenks has researched the financial;pros and cons of entering into a 1-year MBA;program at her state university. The;tuition and books for the master?s program;will have an up-front cost of $50,000. If;she enrolls in an MBA program, Jenny will;quit her current job, which pays $50,000;per year after taxes (for simplicity, treat;any lost earnings as part of the up-front;cost). On average, a person with an MBA;degree earns an extra $20,000 per year (after;taxes) over a business career of 40 years.;Jenny believes that her opportunity cost;of capital is 6%. Given her estimates, find;the net present value (NPV) of entering;this MBA program. Are the benefits of;further education worth the associated costs?;P10?15 Internal rate of return Peace of;Mind, Inc. (PMI), sells extended warranties for durable;consumer goods such as washing machines and;refrigerators. When PMI sells an extended;warranty, it receives cash up front from;the customer, but later PMI must cover any repair;costs that arise. An analyst working for PMI;is considering a warranty for a new line;of big-screen TVs. A consumer who purchases;the 2-year warranty will pay PMI $200.;On average, the repair costs that PMI must;cover will average $106 for each of the warranty?s;2 years. If PMI has a cost of capital of;7%, should it offer this warranty for sale?;P10?21 All techniques, conflicting rankings;Nicholson Roofing Materials, Inc., is considering;two mutually exclusive projects, each with;an initial investment of $150,000.;The company?s board of directors has set a;maximum 4-year payback requirement;and has set its cost of capital at 9%. The;cash inflows associated with the two projects;are shown in the following table.;Cash inflows;(CFt);Year Project A Project B;1 $45,000 $75,000;2 45,000 60,000;3 45,000 30,000;4 45,000;30,000;5 45,000;30,000;6 45,000 30,000;a. Calculate the payback period for each;project.;b. Calculate the NPV of each project at 0%.;c. Calculate the NPV of each project at 9%.;d. Derive the IRR of each project.;e. Rank the projects by each of the;techniques used. Make and justify a recommendation.;f. Go back one more time and calculate the;NPV of each project using a cost of;capital of 12%. Does the ranking of the two;projects change compared to your;answer in part e? Why?;P10?24 All techniques: Decision among;mutually exclusive investments Pound Industries is;attempting to select the best of three;mutually exclusive projects. The initial investment;and after-tax cash inflows associated with;these projects are shown in the;following table.;Cash flows Project;A Project B Project C;Initial investment (CF0) $60,000 $100,000 $110,000;Cash inflows (CFt), t 5 1 to 5 20,000 31,500 32,500;a. Calculate the payback period for each;project.;b. Calculate the net present value (NPV) of;each project, assuming that the firm has;a cost of capital equal to 13%.;c. Calculate the internal rate of return;(IRR) for each project.;d. Draw the net present value profiles for;both projects on the same set of axes, and;discuss any conflict in ranking that may;exist between NPV and IRR.;e. Summarize the preferences dictated by;each measure, and indicate which project;you would recommend. Explain why.

Paper#39367 | Written in 18-Jul-2015

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