Chapter_09_sol_students.pdf

CorporateFinance:TheCore(Berk/DeMarzo)Chapter9-ValuingStocks

1)Whendiscountingdividendsyoushoulduse?A)theweightedaveragecostofcapital.B)theaftertaxweightedaveragecostofcapital.C)theequitycostofcapital.D)thebeforetaxcostofdebt.

Answer:CExplanation: A)

B)C)D)

Diff:1Topic:9.1StockPrices,Returns,andtheInvestmentHorizonSkill:Conceptual

2)Whichofthefollowingstatementsisfalse?A)Theequitycostofcapitalforastockistheexpectedreturnofotherinvestmentsavailableinthemarket

withequivalentrisktothefirmsshares.B)Thepriceofashareofstockisequaltothepresentvalueoftheexpectedfuturedividendsitwillpay.C)IfthecurrentstockpricewerelessthanP0= 1 11 E

Div Pr+

+ ,itwouldbeanegativeNPVinvestment,andwewouldexpectinvestorstorushinandsellit,drivingdownthestocksprice.

D)Thelawofonepriceimpliesthattovalueanysecurity,wemustdeterminetheexpectedcashflowsaninvestorwillreceivefromowningit.


B)C)Inthiscasethestockwouldbeundervaluedandwewouldexpectinvestorstobuyit.D)


3)Whichofthefollowingstatementsisfalse?A)Wemustdiscountthecashflowsfromstockbasedontheequitycostofcapitalforthestock.B)Thedividedyieldisthepercentagereturntheinvestorexpectstoearnfromthedividendpaidbythe

stock.C)Thefirmmightpayoutcashtoitsshareholdersintheformofadividend.D)Thedividendyieldistheexpectedannualdividendofastock,dividedbyitsexpectedfuturesaleprice.

Answer:DExplanation: A)

B)C)D)Thedividendyieldistheannualdividenddividedbythecurrentprice.


4)Whichofthefollowingstatementsisfalse?

A)Futuredividendpaymentsandstockpricesarenotknownwithcertainty;ratherthesevaluesarebasedontheinvestorsexpectationsatthetimethestockispurchased.

B)Thecapitalgainisthedifferencebetweentheexpectedsalepriceandthepurchasepriceofthestock.C)Thesumofthedividendyieldandthecapitalgainrateiscalledthetotalreturnofthestock.D)Wedividethecapitalgainbytheexpectedfuturestockpricetocalculatethecapitalgainrate.


B)C)D)Thecapitalgainsrateisthecapitalgaindividedbythecurrentstockprice.


5)Whichofthefollowingstatementsisfalse?A)Aninvestorwillbewillingtopayuptothepointatwhichthecurrentpriceofashareofstockequals

thepresentvalueoftheexpectedfuturedividendsanexpectedfuturesaleprice.B)Theexpectedtotalreturnofastockshouldequaltheexpectedreturnofotherinvestmentsavailablein

themarketwithequivalentrisk.C)Thetotalamountreceivedindividendsandfromsellingthestockwilldependontheinvestors

investmenthorizon.D)IfthecurrentstockpriceweregreaterthanP0= 1 11 E

Div Pr+

+ ,itwouldbeapositiveNPVinvestment,andwewouldexpectinvestorstorushinandbuyit,drivingupthestocksprice.


B)C)D)ItwouldbeanegativeNPVinvestment.


6)Whichofthefollowingformulasisincorrect?A)CapitalGainsRate= 0 1

0

P PP

B)DividendYield= 10

DivP

C)P0= 11 E

Divr+ +

2 22(1 )E

Div Pr+

+D)rE=CapitalGainsRate+DividendYield

Answer:AExplanation: A)CapitalGainsRate= 1 0

0

P PP

B)C)D)


7)Whichofthefollowingformulasisincorrect?A)P0= 11 E

Divr+ +

2 22(1 )E

Div Pr+

+ +...+ (1 )NN

E

Divr+

B)P0=

1 (1 )

Nnn

En

Divr= +

C)rE= 1 01

Div PP+

D)P0= 1 11 EDiv P

r+

+Answer:CExplanation: A)

B)C)rE= 1 1

0

Div PP+

D)Diff:2Topic:9.1StockPrices,Returns,andtheInvestmentHorizonSkill:Conceptual

Usetheinformationforthequestion(s)below.VonBoraCorporationisexpectedpayadividendof$1.40pershareattheendofthisyearanda$1.50pershareattheendofthesecondyear.YouexpectVonBorasstockpricetobe$25.00attheendoftwoyears.VonBorasequitycostofcapitalis10%

WS1)ThepriceyouwouldbewillingtopaytodayforashareofVonBorastock,ifyouplantoholdthestockfortwoyearsisclosestto:A)$23.15B)$20.65C)$21.95D)$21.90

Answer:AExplanation: A)P0= 11 E

Divr+ +

2 22(1 )E

Div Pr+

+ =1.40

1 .10+ + 21.50 25.00

(1 .10)++ =$23.17

B)C)D)

8)SupposeyouplantoholdVonBorastockforoneyear.ThepricewouldwouldexpecttobeabletosellashareofVonBorastockinoneyearisclosestto:A)$26.50B)$22.70C)$23.15D)$24.10


B)C)D)P1= 2 21(1 )E

Div Pr+

+ = 21.50 25.00

(1 .10)++ =$24.10

Diff:2

Topic:9.1StockPrices,Returns,andtheInvestmentHorizonkill:Analytical

9) Borastockforonlyoneyear.YourcapitalgainfromholdingVonBorastockfo yearisclosestto:

Explanation: A) P1=

S

SupposeyouplantoholdVonrthefirstA)$0.95B)$1.40C)$1.85D)$1.25

Answer:A

2 21(1 )E

Div Pr+

+ =1.50 25.00

(1 .10)++ =$24.10

P0=

11 E

Divr+ +

2 22(1 )E

Div Pr+

+ =1.40

1 .10+ + 21.50 25.00

(1 .10)++ =$23.17

apitalGain=P1-P0=24.10-23.17=$0.93

D)

s,Returns,andtheInvestmentHorizon

10) stockforonlyoneyear.YourcapitalgainratefromholdingVonBorast efirstyearisclosestto:

Explanation:B) P1=

C

B)C)

Diff:2Topic:9.1StockPriceSkill:AnalyticalSupposeyouplantoholdVonBoraockforthA)3.5%B)4.0%C)6.0%D)4.5%

Answer:BA)

2 2

1(1 )E

Div Pr+

+ =1.50 25.00

(1 .10)++ =$24.10

P0=

11 E

Divr+

2 22P+

=(1 )E

Divr+

1.40+1 .10+ + 2

1.50 25.00(1 .10)

++ =$23.17

apitalGainrate=capital =.0401or4.0%

D)

s,Returns,andtheInvestmentHorizonkill:Analytical

11) stockforonlyoneyear.YourdividendyieldfromholdingVonBorast efirstyearisclosestto:

CapitalGain=P1-P0=24.10-23.17=$0.93 C gain/P0 =0.93/23.17

C)

Diff:2Topic:9.1StockPriceS

SupposeyouplantoholdVonBoraockforthA)6.0%B)4.0%C)6.5%D)5.5%

Answer:A

E anation: A)P0=xpl

11 E

Divr+ +

2 22(1 )E

Divr+

+P

= 1.401 .+ 10 + 2

1.50 25.00(1 .10)

++ =$23.17

Dividendyield=Div1/P0=$1.40/23.17=.0604or6.0%

B)C)D)

Diff:2Topic:9.1StockPrices,Returns,andtheInvestmentHorizonSkill:Analytical

WS2)SupposeyouplanonpurchasingVonBorastockinoneyear,rightafterthe$1.40dividendispaid.Youthenplanonsellingyourstockattheendofyeartwo,rightafterthe$1.50dividendispaid.Thecapitalgainratethatyouwillreceiveonyourinvestmentisclosestto:A)4.00%B)3.75%C)6.25%D)3.50%

Answer:BExplanation: A)

B)P1== 2 21(1 )E

Div Pr+

+ =1. =$24.10 50 25.00

(1 .10)++

Socapitalgainrate=(P2-P1)/P1=($25.00-$24.10)/$24.10=.03734or3.73%

C)D)


12)SupposeyouplanonpurchasingVonBorastockinoneyear,rightafterthe$1.40dividendispaid.Youthenplanonsellingyourstockattheendofyeartwo,rightafterthe$1.50dividendispaid.Thedividendyieldthatyouwillreceiveonyourinvestmentisclosestto:A)5.75%B)6.50%C)6.25%D)4.00%


B)C)P1= 2 21(1 )E

Div Pr+

+ =1.50 25.00

(1 .10)++ =$24.10

Sodividendyield=$1.50/$24.10=.0622or6.22%

D)Diff:3Topic:9.1StockPrices,Returns,andtheInvestmentHorizonSkill:Analytical

13)SupposeyouplanonpurchasingVonBorastockinoneyear,rightafterthe$1.40dividendispaid.Youthenplanonsellingyourstockattheendofyeartwo,rightafterthe$1.50dividendispaid.Thetotalreturnthatyouwillreceiveonyourinvestmentisclosestto:A)9.50%B)10.75%C)10.25%D)10.00%


B)C)D)P1= 2 21(1 )E

Div Pr+

+ =1.50 25.00

(1 .10)++ =$24.10

Sodividendyield=$1.50/$24.10=.0622or6.22% Socapitalgainrate=(P2-P1)/P1=($25.00-$24.10)/$24.10=.03734or3.73% Totalreturn=capitalgainsrate+dividendyield=3.73%+6.22%=9.95%


WS3)SupposeyouplantoholdVonBorastockforonlyoneyear.CalculateyourtotalreturnfromholdingVonBorastockforthefirstyear.Answer:P1= 2 21(1 )E

Div Pr+

+ =1.50 25.00

(1 .10)++ =$24.10

P0= 11 E

Divr+ +

2 22(1 )E

Div Pr+

+ =1.40

1 .10+ + 21.50 25.00

(1 .10)++ =$23.17

CapitalGain=P1-P0=24.10-23.17=$0.93 CapitalGainrate=capitalgain/P0=0.93/23.17=.0401or4.0% Dividendyield=Div1/P0=$1.40/23.17=.0604or6.0% Totalreturn=capitalgainrate+dividendyield=4.0%+6.0%=10%


9.2TheDividend-DiscountModel

14)Whichofthefollowingformulasisincorrect?A)Divt=

earningsshares outstanding

t

tDividendPayoutRate

B)PN= NE

Divr g

C)earningsgrowthrate=retentionratexreturnonnewinvestmentD)P0= 11 E

Divr+ +

22(1 )E

Divr+ +...+ (1 )

NN

E

Divr+ +

1(1 )NEr+

1NE

Divr g

+


B)PN= 1NE

Divr g

+

C)D)

Diff:2Topic:9.2TheDividend-DiscountModelSkill:Conceptual

15)JRNenterprisesjustannouncedthatitplanstocutitsdividendfrom$2.50to$1.50pershareandusetheextrafundstoexpanditsoperations.Priortothisannouncement,JRNsdividendswereexpectedtogrowat4%peryearandJRNsstockwastradingat$25.00pershare.Withthenewexpansion,JRNsdividendsareexpectedtogrowat8%peryearindefinitely.AssumingthatJRNsriskisunchangedbytheexpansion,thevalueofashareofJRNaftertheannouncementisclosestto:A)$25.00B)$15.00C)$31.25D)$27.50

Answer:AExplanation: A)Twosteps.

Step#1solveforrE, rE=Div1/P0+g=2.50/25.00+.04=.14or14% Step#2 solvefornewstockprice: P0=Div1/(rE-g)=1.50/(.14-.08)=25.00

B)C)D)

16)YouexpectthatBeanEnterpriseswillhaveearningspershareof$2forthecomingyear.Beanplanstoretainallofitsearningsforthenextthreeyears.Forthesubsequenttwoyears,thefirmplansonretaining50%ofitsearnings.Itwillthenretainonly25%ofitsearningsfromthatpointforward.Retainedearningswillbeinvestedinprojectswithanexpectedreturnof20%peryear.IfBeansequitycostofcapitalis12%,thenthepriceofashareofBeansstockisclosestto:A)$17.00B)$10.75C)$27.75D)$43.50

Answer:C

Explanation: A)B)C)Year Earnings Dividends g

1 $2.00 $0.00 20%2 $2.40 $0.00 20%3 $2.88 $0.00 20%4 $3.46 $1.73 10%5 $3.80 $1.90 10%6 $4.18 $3.14 5% P0=1.73/(1.12)4+1.90/1.125+(3.14/(.12-.05))/1.125=27.63Eachgiscalculatedasthe20%returnontheprojectstheretentionratio.

D)Diff:3Topic:9.2TheDividend-DiscountModelSkill:Analytical

17)MJLTDisexpectedtogrowatvariousratesoverthenextfiveyears.Thecompanyjustpaida$1.00dividend.Thecompanyexpectstogrowat20%forthenexttwoyears(effectingD1andD2),thenthecompanyexpectstogrowat10%forthreeadditionalyears(D3,D4,D5)afterwhichthecompanyexpectstogrowataconstantrateof5%peryearindefinitely.IftherequiredrateofreturnonMJscommonstockis12%,thenwhatisashareofMJsstockworth?Answer:Time

Period Dividend PresentValue1 $1.00(1.20) $1.00(1.20)/(1.12)=1.0712 $1.00(1.20)2 $1.00(1.20)2/(1.12)2=1.1483 $1.00(1.20)2(1.10)1 $1.00(1.20)2(1.10)/(1.12)3=1.1274 $1.00(1.20)2(1.10)2 $1.00(1.20)2(1.10)2/(1.12)4=1.1075 $1.00(1.20)2(1.10)3 $1.00(1.20)2(1.10)3/(1.12)5=1.0886 $1.00(1.20)2(1.10)3(1.05) $1.00(1.20)2(1.10)3(1.05)/[(.12-.05)(1.12)5]=16.313CurrentValueofShare=1.071+1.148+1.127+1.107+1.088+16.313=$21.85

Diff:3Topic:9.2TheDividend-DiscountModelSkill:Analytical

18)GrowingRealFastCompany(GRF)isexpectedtohavea25percentgrowthrateforthenextfouryears(effectingD1,D2,D3,andD4).Beginninginyearfive,thegrowthrateisexpectedtodropto7percentperyearandlastindefinitely.IfGRFjustpaida$2.00dividendandtheappropriatediscountrateis15percent,thenwhatisthevalueofashareofGRE?Answer:Time

Period Dividend PresentValue1 $2.50(1.25)1 $2.00(1.25)/(1.15)=2.1742 $2.00(1.25)2 $2.00(1.25)2/(1.15)2=2.3633 $2.00(1.25)3 $2.00(1.25)3/(1.15)3=2.5684 $2.00(1.25)4 $2.00(1.25)4/(1.15)4=2.7925 $2.00(1.25)4(1.07) $2.00(1.25)4(1.07)/[(.15-.07)(1.15)4]=37.34

CurrentValueof Share=2.174+2.363+2.568+2.792+37.34=$47.24Diff:3Topic:9.2TheDividend-DiscountModelSkill:Analytical

9.3TotalPayoutandFreeCashFlowValuationModels

19)Whichofthefollowingequationsisincorrect?A)P0= 0

+ Debt - CashShares OutstandingV

B)V0=(1 )

NN

wacc

FCFr+ (1 )

NN

wacc

Vr+

11 wacc

FCFr+

22(1 )wacc

FCFr++ +...+ +

C)FreeCashFlow=EBIT(1-c)+Depreciation-CapitalExpenditures-DNWCD)EnterpriseValue=MarketValueofEquity+Debt-Cash

Answer:AExplanation: A)

P0= 0+ Debt - Cash

Shares OutstandingV

B)C)D)

Diff:2Topic:9.3TotalPayoutandFreeCashFlowValuationModelsSkill:Conceptual

20)TheRufusCorporationhas125millionsharesoutstandingandanalystsexpectRufustohaveearningsof$500millionthisyear.Rufusplanstopayout40%ofitsearningsindividendsandtheyexpecttouseanother20%oftheirearningstorepurchaseshares.IfRufusequitycostofcapitalis15%andRufusearningsareexpectedtogrowatarateof3%peryear,thenthevalueofashareofRufusstockisclosestto:A)$13.35B)$33.50C)$20.00D)$16.00


B)C)Dividends=$500.40=$200million

Repurchases=$500.20=$100million PV(FutureTotalDividendsandRepurchases)=($200+$100)/(.15-.03)=$2,500million P0=$2,500million/125millionshares=$20pershare

D)Diff:2Topic:9.3TotalPayoutandFreeCashFlowValuationModelsSkill:Analytical

Usetheinformationforthequestion(s)below.YouexpectCCMCorporationtogeneratethefollowingfreecashflowsoverthenextfiveyears: Year 1 2 3 4 5FCF($millions) 25 28 32 37 40 Followingyearfive,youestimatethatCCMsfreecashflowswillgrowat5%peryearandthatCCMsweightedaveragecostofcapitalis13%.

21)TheenterprisevalueofCCMcorporationisclosestto:A)$396millionB)$290millionC)$382millionD)$350million

Answer:AExplanation: A)V0=

(1 )N

Nwacc

FCFr+ (1 )

NN

wacc

Vr+

11 wacc

FCFr+

22(1 )wacc

FCFr++ +...+ +

4

40.13 .05(1 .13)

+

251 .13+ 2

28(1 .13)+ 3

32(1 .13)+ 4

37(1 .13)+V0= + + =395.58million + +

B)C)D)

Diff:2Topic:9.3TotalPayoutandFreeCashFlowValuationModelsSkill:Analytical

22)IfCCMhas$150millionofdebtand12millionsharesofstockoutstanding,thenthesharepriceforCCMisclosestto:A)$49.50B)$11.25C)$20.50D)$22.75


B)C)V0= 11 wacc

FCFr+ +

22(1 )wacc

FCFr+ +...+ (1 )

NN

wacc

FCFr+ + (1 )

NN

wacc

Vr+

4

40.13 .05(1 .13)

+

251 .13+ 2

28.13)+V0= + (1 + 3

32(1 .13)+ + 4

37(1 .13)+ =395.58millionor396million. +

Equityvalue=$396-$150(debt)=$246million/12millionshares=$20.50

D)Diff:2Topic:9.3TotalPayoutandFreeCashFlowValuationModelsSkill:Analytical

Usetheinformationforthequestion(s)below.YouexpectDMCorporationtogeneratethefollowingfreecashflowsoverthenextfiveyears: Year 1 2 3 4 5FCF($millions) 75 84 96 111 120 Beginningwithyearsix,youestimatethatDMsfreecashflowswillgrowat6%peryearandthatDMsweightedaveragecostofcapitalis15%.

23)IfDMhas$500millionofdebtand14millionsharesofstockoutstanding,thenwhatisthepricepershareforDMCorporation?

a) 37.00b) 38.00c) 39.00d) 40.00

Answer:V0=

(1 )N

Nwacc

FCFr+ (1 )

NN

wacc

Vr+

11 wacc

FCFr+

22(1 )wacc

FCFr++ +...+ +

5

120.15 .06(1 .15)

+2

84(1 .15)+ 3

96(1 .15)+ 4

111(1 .15)+ 5

120(1 .15)+

751 .15+V0= + + + + + =1017.66millionor$1018

million Equityvalue=$1018-$500(debt)=$518million/14millionshares=$37.00

Diff:3Topic:9.3TotalPayoutandFreeCashFlowValuationModelsSkill:Analytical

9.4ValuationBasedonComparableFirms

24)Whichofthefollowingstatementsisfalse?

A)Thefactthatafirmhasanexceptionalmanagementteam,hasdevelopedanefficientmanufacturingprocess,orhasjustsecuredapatientonanewtechnologyisignoredwhenweapplyavaluationmultiple.

B)Valuationmultipleshavetheadvantagethattheyallowustoincorporatespecificinformationaboutthefirmscostofcapitalorfuturegrowth.

C)Forfirmswithsubstantialtangibleassets,theratioofpricetobookvalueofequitypershareissometimesused.

D)Usingmultipleswillnothelpusdetermineifanentireindustryisovervalued.Answer:BExplanation: A)

B)Discountedcashflowsmethodshavetheadvantagethattheyallowustoincorporatespecificinformationaboutthefirmscostofcapitalorfuturegrowth.

C)D)

Diff:3Topic:9.4ValuationBasedonComparableFirmsSkill:Conceptual

Usetheinformationforthequestion(s)below.SupposethatTexasTrucking(TT)hasearningspershareof$3.45andEBITDAof$45million.TTalsohas5millionsharesoutstandinganddebto$150million(netofcash).YoubelievethatOklahomaLogisticsandTransport(OLT)iscomparabletoTTintermsofitsunderlyingbusiness,butOLThasnodebt.OLThasaP/Eof12.5andanenterprisevaluetoEBITDAmultipleof7.

25)Baseduponthepriceearningsmultiple,thevalueofashareofTexasTruckingisclosestto:A)$49.30B)$43.10C)$24.15D)$27.60


B)Price=forwardearningsP/E=3.4512.5=43.12C)D)

Diff:2Topic:9.4ValuationBasedonComparableFirmsSkill:AnalyticalBasedupontheenterprisevaluetoEBITDAratio,thevalueofashareofTexasTruckingisclosestto:11)A)$33.00B)$82.50C)$43.10D)$21.25

Answer:AExplanation: A)Enterprisevalue=EBITDAmultiple=$457=$315-$150debt=$165equityvalue/5

millionshares=$33.00pershareB)C)D)

Diff:2Topic:9.4ValuationBasedonComparableFirmsSkill:Analytical

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