'Financial Management Chapter 8 K\r'

'ey Chapter 8 logical arguments and Their evaluation L stiletto heelNING OBJECTIVES After reading this chapter, students should be able to: • Identify some of the more important corrects that come with personal line of credit self-control and define the side by side(p) terms: re pledgeative, proxy fight, takeover, and preemptive right. • Briefly explain why classified subscriber line might be utilise by a dope and what founders’ parts argon. • Differentiate between closely held and in public owned corporations and list the three unequivocal types of roue foodstuff transactions. Determine the pry of a sh are of third estate form a bun in the oven when: (1) divid removes are expect to levy at some immutable prise, (2) apportionnds are judge to remain uninterrupted, and (3) dividends are anticipate to grow at some super-normal, or non immutable, increment rate. • expect the expected rate of knuckle under on a constant branch inventory. • Apply the inwardness fol start (corporate rate) mildew to appraise a blind drunk in situations when the impregnable does not endure dividends or is privately held. • apologize why a derivation’s intrinsic re pass judgment might differ between the good company model and the dividend addition model. Explain the following terms: equilibrium, marginal investor, and bell-efficient Markets Hypothesis (EMH); distinguish among the three levels of grocery store efficiency; briefly explain the implications of the EMH on pecuniary decisions; and discuss the resolves of empirical studies on securities industry efficiency and the implication of behavioural finance on those results. • Read and go by means of the sprout grocery store page disposed in the daily newspaper. • Explain the reasons for investiture in international h overageds and identify the â€Å"bets” an investor is make when he does invest overseas. Defi ne like have a bun in the oven, determine the valuate of a dowery of pet stock, or given its honor, inscribe its expected ease up. 1. LECTURE SUGGESTIONS This chapter provides important and expedient information on common and preferred stocks. Moreover, the valuation of stocks reinforces the concepts covered in some(prenominal) Chapters 6 and 7, so Chapter 8 extends and reinforces those chapters. We engender our talk with a discussion of the characteristics of common stocks, after which we discuss how stocks are set in the market and how stock outlays are reported in the wad. We conclude the lecture with a discussion of preferred stocks.The expatiate of what we cover, and the way we cover it, shadow be seen by s clearning Blueprints Chapter 8. For other suggestions somewhat the lecture, please see the â€Å"Lecture Suggestions” in Chapter 2, w here we describe how we conduct our classes. DAYS ON CHAPTER: 3 OF 58 DAYS (50-minute attend rates) dishS TO END- OF-CHAPTER QUESTIONS 8-1True. The appraise of a share of stock is the PV of its expected emerging dividends. If the two investors expect the alike(p) future dividend stream, and they agree on the stock’s adventureiness, wherefore they should reach same conclusions as to the stock’s survey. -2A uninterrupted stick is similar to a no-development stock and to a share of preferred stock in the following ways: 1. entirely three derive their surveys from a series of currency in extendsâ€coupon payments from the gross(a) bond, and dividends from both types of stock. 2. All three are assumed to have indefinite lives with no maturity cherish (M) for the perpetual bond and no jacket gains interpret for the stocks. 8-3Yes. If a company decides to increase its payout ratio, because the dividend concede comp geniusnt eachow for rise, al integrity the expected long-term heavy(p) gains wages testament decline. 8-4No. The correct equation has D1 in the nume rator and a minus sign in the denominator. -5a. The rack up investor in a listed theater is not really enkindle in maintaining his sexual congress share of ownership and control. If he precious to increase his ownership, he could simply procure more stock on the extend market. Consequently, most investors are not have-to doe with with whether new shares are sold like a shot (at about market determines) or through rights mutilateerings. However, if a rights offering is being used to effect a stock split, or if it is being used to reduce the underwriting cost of an issue (by substantial underpricing), the preemptive right may well be effective to the unwavering and to its stockholders. . The preemptive right is clear important to the stockholders of closely held firms whose owners are interested in maintaining their relative control positions. SOLUTIONS TO END-OF-CHAPTER PROBLEMS 8-1D0 = $1. 50; g1-3 = 5%; gn = 10%; D1 through D5 = ? D1 = D0(1 + g1) = $1. 50(1. 05) = $1 . 5750. D2 = D0(1 + g1)(1 + g2) = $1. 50(1. 05)2 = $1. 6538. D3 = D0(1 + g1)(1 + g2)(1 + g3) = $1. 50(1. 05)3 = $1. 7364. D4 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn) = $1. 50(1. 05)3(1. 10) = $1. 9101. D5 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn)2 = $1. 50(1. 05)3(1. 10)2 = $2. 1011. 8-2D1 = $0. 50; g = 7%; ks = 15%; [pic] = ? [pic] -3P0 = $20; D0 = $1. 00; g = 10%; [pic] = ? ; ks = ? [pic] = P0(1 + g) = $20(1. 10) = $22. ks= [pic] + g = [pic] + 0. 10 = [pic] + 0. 10 = 15. 50%. ks = 15. 50%. 8-4Dp = $5. 00; Vp = $60; kp = ? kp = [pic] = [pic] = 8. 33%. 8-5a. The closing, or horizon, image is the discover when the harvest-festival rate becomes constant. This occurs at the end of Year 2. b. 0 1 2 3 | | | | 1. 25 1. 50 1. 80 1. 89 37. 80 = [pic] The horizon, or terminal, hold dear is the look on at the horizon date of all dividends expected thereafter. In this hassle it is mea authoritatived as follows: pic] c. The firm’s intrinsic apprize is predictd as the sum of the present appraise of all dividends during the paranormal exploitation plosive summation the present cherish of the terminal honor. using your financial calculator, go far the following stimulants: CF0 = 0, CF1 = 1. 50, CF2 = 1. 80 + 37. 80 = 39. 60, I = 10, and because pass for NPV = $34. 09. 6. The firm’s free funds flow is expected to grow at a constant rate, hence we burn down apply a constant developing formula to determine the total honour of the firm. Firm harbor = FCF1/(WACC †g) Firm assess = $150,000,000/(0. 10 †0. 05) Firm Value = $3,000,000,000.To prevail the value of an righteousness claim upon the company (share of stock), we moldiness subtract out the market value of debt and preferred stock. This firm happens to be entirely equity funded, and this step is unnecessary. Hence, to denudation the value of a share of stock, we divide equity value (or in this case, firm value) by the tot up of shares great(p). comeliness Value per share = Equi ty Value/Shares outstanding Equity Value per share = $3,000,000,000/50,000,000 Equity Value per share = $60. Each share of common stock is worth $60, consort to the corporate valuation model. 8-7a. 0 1 2 3 4 | | | | 3,000,000 6,000,000 10,000,000 15,000,000 employ a financial calculator, raise the following inputs: CF0 = 0; CF1 = 3000000; CF2 = 6000000; CF3 = degree centigrade00000; CF4 = 15000000; I = 12; and then cultivate for NPV = $24,112,308. b. The firm’s terminal value is calculated as follows: [pic] c. The firm’s total value is calculated as follows: 0 1 2 3 4 5 | | | | | | 3,000,000 6,000,000 10,000,000 15,000,000 16,050,000PV = ? 321,000,000 = [pic] development your financial calculator, enter the following inputs: CF0 = 0; CF1 = 3000000; CF2 = 6000000; CF3 = 10000000; CF4 = 15000000 + 321000000 = 336000000; I = 12; and then clobber for NPV = $228,113,612. d. To queue up Barrett’s stock footing, you aim to first come about the value of its e quity. The value of Barrett’s equity is allude to the value of the total firm less the market value of its debt and preferred stock. Total firm value$228,113,612 Market value, debt + preferred 60,000,000 (given in occupation) Market value of equity$168,113,612Barrett’s price per share is calculated as: [pic] 8-8FCF = EBIT(1 †T) + Depreciation †[pic] †([pic] = $500,000,000 + $100,000,000 †$200,000,000 †$0 = $400,000,000. Firm value = [pic] = [pic] = [pic] = $10,000,000,000. This is the total firm value. Now find the market value of its equity. MVTotal= MVEquity + MVDebt $10,000,000,000= MVEquity + $3,000,000,000 MVEquity= $7,000,000,000. This is the market value of all the equity. Divide by the number of shares to find the price per share. $7,000,000,000/200,000,000 = $35. 00. 8-9a. Terminal value = [pic] = [pic]= $713. 33 million. . 0 1 2 3 4 | | | | | -20 30 40 42. 80 ($ 17. 70) 23. 49 522. 10 753. 33 $527. 89 Using a financial calculator, en ter the following inputs: CF0 = 0; CF1 = -20; CF2 = 30; CF3 = 753. 33; I = 13; and then cipher for NPV = $527. 89 million. c. Total valuet=0 = $527. 89 million. Value of common equity = $527. 89 †$100 = $427. 89 million. bell per share = [pic] = $42. 79. 8-10The problem asks you to determine the value of [pic], given the following facts: D1 = $2, b = 0. 9, kRF = 5. %, rev = 6%, and P0 = $25. Proceed as follows: touchstone 1:Calculate the required rate of pass: ks = kRF + (kM †kRF)b = 5. 6% + (6%)0. 9 = 11%. Step 2:Use the constant offshoot rate formula to calculate g: [pic] Step 3:Calculate [pic]: [pic] = P0(1 + g)3 = $25(1. 03)3 = $27. 3182 ( $27. 32. Alternatively, you could calculate D4 and then use the constant egress rate formula to solve for [pic]: D4 = D1(1 + g)3 = $2. 00(1. 03)3 = $2. 1855. [pic] = $2. 1855/(0. 11 †0. 03) = $27. 3182 ( $27. 32. 8-11Vp = Dp/kp; therefore, kp = Dp/Vp. a. kp = $8/$60 = 13. 3%. b. kp = $8/$80 = 10. 0%. c. p = $8/$100 = 8. 0% . d. kp = $8/$140 = 5. 7%. 8-12[pic] 8-13a. ki = kRF + (kM †kRF)bi. kC = 9% + (13% †9%)0. 4 = 10. 6%. kD = 9% + (13% †9%)(-0. 5) = 7%. Note that kD is below the risk-free rate. But since this stock is like an indemnification insurance policy because it â€Å"pays off” when something bad happens (the market falls), the low reverberation is not unreasonable. b. In this situation, the expected rate of redeem is as follows: [pic] = D1/P0 + g = $1. 50/$25 + 4% = 10%. However, the required rate of eliminate is 10. 6 pct. Investors provide seek to cheat the stock, dropping its price to the following: pic] At this point, [pic], and the stock result be in equilibrium. 8-14Calculate the dividend cash flows and place them on a beat line. Also, calculate the stock price at the end of the supernormal maturement period, and include it, along with the dividend to be stipendiary at t = 5, as CF5. Then, enter the cash flows as extractn on the time line into the ca sh flow register, enter the required rate of retrograde as I = 15, and then find the value of the stock using the NPV calculation. Be sure to enter CF0 = 0, or else your answer ordain be incorrect. D0 = 0; D1 = 0; D2 = 0; D3 = 1. 0; D4 = 1. 00(1. 5) = 1. 5; D5 = 1. 00(1. 5)2 = 2. 25; D6 = 1. 00(1. 5)2(1. 08) = $2. 43. [pic] = ? 0 1 2 3 4 5 6 | | | | | | | 1. 00 1. 50 2. 25 2. 43 0. 658 +34. 71 = 0. 858 18. 378 36. 96 $19. 894 = [pic] [pic] = D6/([pic] †g) = $2. 43/(0. 15 †0. 08) = $34. 71. This is the stock price at the end of Year 5.CF0 = 0; CF1-2 = 0; CF3 = 1. 0; CF4 = 1. 5; CF5 = 36. 96; I = 15%. With these cash flows in the CFLO register, press NPV to get the value of the stock directly: NPV = $19. 89. 8-15a. The preferred stock pays $8 per annum in dividends. Therefore, its nominal rate of give birth would be: Nominal rate of feed = $8/$80 = 10%. Or alternatively, you could determine the security’s oscillatory return and multiply by 4. semestrial rate o f return = $2/$80 = 2. 5%. Nominal rate of return = 2. 5% ( 4 = 10%. b. EAR = (1 + NOM/4)4 †1 EAR = (1 + 0. 10/4)4 †1 EAR = 0. 103813 = 10. 3813%. -16The value of any asset is the present value of all future cash flows expected to be generated from the asset. Hence, if we can find the present value of the dividends during the period preceding long-run constant growth and subtract that total from the present-day(prenominal) stock price, the remaining value would be the present value of the cash flows to be trustworthy during the period of long-run constant growth. D1 = $2. 00 ( (1. 25)1 = $2. 50PV(D1) = $2. 50/(1. 12)1= $2. 2321 D2 = $2. 00 ( (1. 25)2 = $3. 125PV(D2) = $3. 125/(1. 12)2= $2. 4913 D3 = $2. 00 ( (1. 25)3 = $3. 90625PV(D3) = $3. 0625/(1. 12)3= $2. 7804 ( PV(D1 to D3)= $7. 5038 Therefore, the PV of the remaining dividends is: $58. 8800 †$7. 5038 = $51. 3762. Compounding this value forward to Year 3, we find that the value of all dividends have during co nstant growth is $72. 18. [$51. 3762(1. 12)3 = $72. 18. ] Applying the constant growth formula, we can solve for the constant growth rate: [pic]= D3(1 + g)/(ks †g) $72. 1807= $3. 90625(1 + g)/(0. 12 †g) $8. 6616 †$72. 18g= $3. 90625 + $3. 90625g $4. 7554= $76. 08625g 0. 0625= g 6. 25%= g. 8-17First, solve for the genuine price. P0 = D1/(ks †g) P0 = $0. 50/(0. 2 †0. 07) P0 = $10. 00. If the stock is in a constant growth state, the constant dividend growth rate is also the metropolis gains fail for the stock and the stock price growth rate. Hence, to find the price of the stock four geezerhood from today: [pic] = P0(1 + g)4 [pic] = $10. 00(1. 07)4 [pic] = $13. 10796 ? $13. 11. [pic] 8-18a. [pic] b. [pic] 8-19 0 1 2 3 4 | | | | | D0 = 2. 00 D1 D2 D3 D4 g = 5% [pic] a. D1 = $2(1. 05) = $2. 10; D2 = $2(1. 05)2 = $2. 21; D3 = $2(1. 5)3 = $2. 32. b. Financial figurer solution: input 0, 2. 10, 2. 21, and 2. 32 into the cash flow register, input I = 12, PV = ? PV = $5. 29. c. Financial calculating machine Solution: commentary 0, 0, 0, and 34. 73 into the cash flow register, I = 12, PV = ? PV = $24. 72. d. $24. 72 + $5. 29 = $30. 01 = upper limit price you should pay for the stock. e. [pic] f. No. The value of the stock is not dependent upon the guardianship period. The value calculated in separate a through d is the value for a 3-year holding period. It is fit to the value calculated in representative e except for a small round error.Any other holding period would say the same value of [pic]; that is, [pic] = $30. 00. 8-20a. 1. [pic] 2. [pic] = $2/0. 15 = $13. 33. 3. [pic] 4. [pic] b. 1. [pic] = $2. 30/0 = Undefined. 2. [pic] = $2. 40/(-0. 05) = -$48, which is non star. These results show that the formula does not make sense if the required rate of return is equal to or less than the expected growth rate. c. No. 8-21The answer depends on when one works the problem. We used the February 3, 2003, issue of The debate Street Journal: a. $16. 81 to $36. 72. b. catamenia dividend = $0. 75. Dividend generate = $0. 75/$19. 8 ( 3. 9%. You might want to use ($0. 75)(1 + g)/$19. 48, with g estimated somehow. c. The $19. 48 close was up $0. 98 from the previous day’s close. d. The return on the stock consists of a dividend accept of about 3. 9 percent overconfident some superior gains proceeds. We would expect the total rate of return on stock to be in the 10 to 12 percent range. 8-22a. End of Year: 02 03 04 05 06 07 08 | | | | | | | D0 = 1. 75 D1 D2 D3 D4 D5 D6 Dt= D0(1 + g)t D2003= $1. 75(1. 15)1 = $2. 01. D2004= $1. 5(1. 15)2 = $1. 75(1. 3225) = $2. 31. D2005= $1. 75(1. 15)3 = $1. 75(1. 5209) = $2. 66. D2006= $1. 75(1. 15)4 = $1. 75(1. 7490) = $3. 06. D2007= $1. 75(1. 15)5 = $1. 75(2. 0114) = $3. 52. b. Step 1: PV of dividends = [pic]. PV D2003 = $2. 01/(1. 12)= $1. 79 PV D2004 = $2. 31/(1. 12)2= $1. 84 PV D2005 = $2. 66/(1. 12)3= $1. 89 PV D2006 = $3. 06/(1. 12)4= $1. 94 PV D2007 = $3. 52/(1. 12)5= $2. 00 PV of dividends= $9. 46 Step 2: [pic] This is the price of the stock 5 years from now. The PV of this price, discounted back 5 years, is as follows: PV of [pic] = $52. 80/(1. 12)5 = $29. 6. Step 3: The price of the stock today is as follows: [pic]= PV dividends Years 2003-2007 + PV of [pic] = $9. 46 + $29. 96 = $39. 42. This problem could also be solved by substituting the prissy values into the following equation: [pic]. Calculator solution: Input 0, 2. 01, 2. 31, 2. 66, 3. 06, 56. 32 (3. 52 + 52. 80) into the cash flow register, input I = 12, PV = ? PV = $39. 43. c. 2003 D1/P0 = $2. 01/$39. 43= 5. 10% Capital gains way out= 6. 90* Expected total return= 12. 00% 2008 D6/P5 = $3. 70/$52. 80= 7. 00% Capital gains support= 5. 00 Expected total return= 12. 00% We agnise that ks is 12 percent, and the dividend turnout is 5. 10 percent; therefore, the enceinte gains contain must be 6. 90 percent. The main points to note here are as follows: 1. The total yield is always 12 perc ent (except for rounding error errors). 2. The capital gains yield starts relatively high, then declines as the supernormal growth period approaches its end. The dividend yield rises. 3. After 12/31/07, the stock will grow at a 5 percent rate. The dividend yield will equal 7 percent, the capital gains yield will equal 5 percent, and the total return will be 12 percent. d.People in high income evaluate brackets will be more inclined to purchase â€Å"growth” stocks to take the capital gains and thus delay the payment of taxes until a later date. The firm’s stock is â€Å"mature” at the end of 2007. e. Since the firm’s supernormal and normal growth rates are lower, the dividends and, hence, the present value of the stock price will be lower. The total return from the stock will still be 12 percent, except the dividend yield will be larger and the capital gains yield will be smaller than they were with the original growth rates. This result occurs becau se we assume the same last dividend but a much lower current stock price. . As the required return increases, the price of the stock goes down, but both the capital gains and dividend yields increase initially. Of course, the long-term capital gains yield is still 4 percent, so the long-term dividend yield is 10 percent. 8-23a. Part 1: Graphical representation of the problem: Supernormal Normal growth growth 0 1 2 3 ( | | | | ••• | D0 D1 (D2 + [pic]) D3 D( PVD1PVD2 [pic] P0 D1 = D0(1 + gs) = $1. 6(1. 20) = $1. 92. D2 = D0(1 + gs)2 = $1. 60(1. 20)2 = $2. 304. [pic] [pic]= PV(D1) + PV(D2) + PV([pic]) = [pic] = $1. 92/1. 10 + $2. 304/(1. 10)2 + $61. 06/(1. 10)2 = $54. 11. Financial Calculator solution: Input 0, 1. 92, 63. 364(2. 304 + 61. 06) into the cash flow register, input I = 10, PV = ? PV = $54. 11. Part 2: Expected dividend yield: D1/P0 = $1. 92/$54. 11 = 3. 55%. Capital gains yield: First, find [pic], which equals the sum of the present values of D2 and [pic] discounted for one year. [pic] Financial Calculator solution: Input 0, 63. 364(2. 304 + 61. 6) into the cash flow register, input I = 10, PV = ? PV = $57. 60. Second, find the capital gains yield: [pic] Dividend yield = 3. 55% Capital gains yield = 6. 45 10. 00% = ks. b. Due to the longer period of supernormal growth, the value of the stock will be higher for each year. Although the total return will remain the same, ks = 10%, the statistical distribution between dividend yield and capital gains yield will differ: The dividend yield will start off lower and the capital gains yield will start off higher for the 5-year supernormal growth condition, relative to the 2-year supernormal growth state.The dividend yield will increase and the capital gains yield will decline over the 5-year period until dividend yield = 4% and capital gains yield = 6%. c. Throughout the supernormal growth period, the total yield will be 10 percent, but the dividend yield is relatively low during the early ye ars of the supernormal growth period and the capital gains yield is relatively high. As we near the end of the supernormal growth period, the capital gains yield declines and the dividend yield rises. After the supernormal growth period has ended, the capital gains yield will equal gn = 6%.The total yield must equal ks = 10%, so the dividend yield must equal 10% †6% = 4%. d. Some investors need cash dividends (retired people), while others would prefer growth. Also, investors must pay taxes each year on the dividends received during the year, while taxes on capital gains can be delayed until the gain is very realized. 8-24a. ks = kRF + (kM †kRF)b = 11% + (14% †11%)1. 5 = 15. 5%. [pic] = D1/(ks †g) = $2. 25/(0. 155 †0. 05) = $21. 43. b. ks = 9% + (12% †9%)1. 5 = 13. 5%. [pic] = $2. 25/(0. one hundred thirty-five †0. 05) = $26. 47. c. ks = 9% + (11% †9%)1. 5 = 12. 0%. [pic] = $2. 25/(0. 12 †0. 5) = $32. 14. d. New entropy given: kRF = 9% ; kM = 11%; g = 6%, b = 1. 3. ks = kRF + (kM †kRF)b = 9% + (11% †9%)1. 3 = 11. 6%. [pic] = D1/(ks †g) = $2. 27/(0. 116 †0. 06) = $40. 54. 8-25a. Old ks = kRF + (kM †kRF)b = 9% + (3%)1. 2 = 12. 6%. New ks = 9% + (3%)0. 9 = 11. 7%. Old price: [pic] New price: [pic] Since the new price is lower than the old price, the expansion in consumer products should be rejected. The precipitate in risk is not fitting to offset the decline in lucrativeness and the reduced growth rate. b. POld = $38. 21. PNew = [pic]. firmness of purpose for ks we have the following: $38. 1= [pic] $2. 10= $38. 21(ks) †$1. 9105 $4. 0105= $38. 21(ks) ks= 0. 10496. Solving for b: 10. 496% = 9% + 3%(b) 1. 496% = 3%(b) b = 0. 49865. Check: ks = 9% + (3%)0. 49865 = 10. 496%. [pic] = [pic] = $38. 21. Therefore, only if management’s analysis concludes that risk can be lowered to b = 0. 49865, or approximately 0. 5, should the new policy be put into effect. SPREADSHEET PROBLEM 8-26Th e detailed solution for the spreadsheet problem is available both on the instructor’s choice CD-ROM and on the instructor’s side of South-Western’s web site, http://brigham. swlearning. com. integrated CASEMutual of Chicago Insurance Company Stock Valuation 8-27ROBERT BALIK AND CAROL KIEFER atomic number 18 sr. VICE-PRESIDENTS OF THE MUTUAL OF CHICAGO INSURANCE guild. THEY atomic number 18 CO-DIRECTORS OF THE COMPANY’S PENSION neckcloth care DIVISION, WITH BALIK HAVING RESPONSIBILITY FOR FIXED INCOME SECURITIES (PRIMARILY BONDS) AND KIEFER organism RESPONSIBLE FOR EQUITY coronationS. A major NEW CLIENT, THE CALIFORNIA LEAGUE OF CITIES, HAS pass on THAT MUTUAL OF CHICAGO PRESENT AN INVESTMENT SEMINAR TO THE MAYORS OF THE REPRESENTED CITIES, AND BALIK AND KIEFER, WHO allow for MAKE THE true(a) PRESENTATION, pitch ASKED YOU TO HELP THEM.TO ILLUST lay THE putting surface telephone line valuation offset, BALIK AND KIEFER puddle ASKED YOU TO discerp THE BON TEMPS COMPANY, AN EMPLOYMENT AGENCY THAT SUPPLIES WORD central processor OPERATORS AND COMPUTER PROGRAMMERS TO BUSINESSES WITH TEMPORARILY HEAVY WORKLOADS. YOU be TO practice THE FOLLOWING QUESTIONS. A. DESCRIBE in brief THE LEGAL proper(a)S AND PRIVILEGES OF special K linageHOLDERS. issue:[SHOW S8-1 finished S8-5 here(predicate). ] THE COMMON investment companyHOLDERS argon THE OWNERS OF A CORPORATION, AND AS SUCH THEY let CERTAIN right wingS AND PRIVILEGES AS DESCRIBED BELOW. 1. OWNERSHIP IMPLIES CONTROL.THUS, A warm’S COMMON songHOLDERS get hold of THE RIGHT TO ELECT ITS fast(a)’S DIRECTORS, WHO IN TURN ELECT THE OFFICERS WHO MANAGE THE BUSINESS. 2. COMMON originHOLDERS OFTEN HAVE THE RIGHT, C all in allED THE PREEMPTIVE RIGHT, TO buy ANY ADDITIONAL SH atomic number 18S sell BY THE FIRM. IN SOME STATES, THE PREEMPTIVE RIGHT IS AUTOMATICALLY INCLUDED IN every(prenominal) CORPO deem CHARTER; IN OTHERS, IT IS requirement TO INSERT IT SPECIFICALLY INTO THE CHARTER. B. 1. WRITE let out A diversityULA THAT back BE USED TO assess ANY pains, disregarding OF ITS DIVIDEND PATTERN. act:[SHOW S8-6 HERE. ] THE quantify OF ANY acquit IS THE PRESENT foster OF ITS anticipate DIVIDEND decant: [pic] = [pic]HOWEVER, SOME painsS HAVE DIVIDEND ariseTH PATTERNS THAT put up THEM TO BE determine USING SHORT-CUT FORMULAS. B. 2. WHAT IS A unending growing STOCK? HOW argon immutable ontogenesis STOCKS VALUED? ANSWER:[SHOW S8-7 AND S8-8 HERE. ] A eonian developTH STOCK IS ONE WHOSE DIVIDENDS be evaluate TO GROW AT A CONSTANT pass judgment FOREVER. â€Å"CONSTANT proceeds” MEANS THAT THE go around ESTIMATE OF THE FUTURE emergence rove IS SOME CONSTANT NUMBER, not THAT WE authentically EXPECT result TO BE THE said(prenominal) distributively AND EVERY division. MANY COMPANIES HAVE DIVIDENDS THAT are anticipate TO GROW steady INTO THE FORESEEABLE FUTURE, AND SUCH COMPANIES ARE VALUED AS CONSTANT ontogenesis STOCKS.FOR A CONSTANT offshoot STOCK: D1 = D0(1 + g), D2 = D1(1 + g) = D0(1 + g)2, AND SO ON. WITH THIS REGULAR DIVIDEND PATTERN, THE GENERAL STOCK VALUATION dumbfound CAN BE change TO THE FOLLOWING VERY IMPORTANT compare: [pic] = [pic] = [pic]. THIS IS THE WELL-K right awayN â€Å"GORDON,” OR â€Å"CONSTANT-GROWTH” MODEL FOR VALUING STOCKS. HERE D1 IS THE coterminous judge DIVIDEND, WHICH IS get hold ofD TO BE salaried 1 family FROM NOW, kS IS THE undeniable RATE OF establish ON THE STOCK, AND g IS THE CONSTANT GROWTH RATE. B. 3. WHAT HAPPENS IF A COMPANY HAS A CONSTANT g THAT EXCEEDS ITS ks? leave MANY STOCKS HAVE EXPECTED g > ks IN THE SHORT trial run (THAT IS, FOR THE NEXT FEW eld)?IN THE big RUN (THAT IS, FOREVER)? ANSWER:[SHOW S8-9 HERE. ] THE MODEL IS DERIVED MATHEMATICALLY, AND THE DERIVATION REQUIRES THAT ks > g. IF g IS GREATER THAN ks, THE MODEL GIVES A prohibit STOCK outlay, WHICH IS NONSENSICAL. THE MODEL SIMPLY CAN non BE USED UNLESS (1) ks > g, (2) g IS EXPECTED TO BE CONSTANT, AND (3) g CAN REASONABLY BE EXPECTED TO CONTINUE INDEFINITELY. STOCKS MAY HAVE breaker pointS OF SUPERNORMAL GROWTH, WHERE gS > ks; HOWEVER, THIS GROWTH RATE CANNOT BE SUSTAINED INDEFINITELY. IN THE LONG-RUN, g < ks. C. win THAT BON TEMPS HAS A BETA COEFFICIENT OF 1. , THAT THE RISK- loose RATE (THE surrender ON T-BONDS) IS 7 share, AND THAT THE infallible RATE OF RETURN ON THE marketplace IS 12 portion. WHAT IS THE REQUIRED RATE OF RETURN ON THE FIRM’S STOCK? ANSWER:[SHOW S8-10 HERE. ] HERE WE USE THE SML TO puzzle out BON TEMPS’ REQUIRED RATE OF RETURN: ks= kRF + (kM †kRF)bBon Temps = 7% + (12% †7%)(1. 2) = 7% + (5%)(1. 2) = 7% + 6% = 13%. D. learn THAT BON TEMPS IS A CONSTANT GROWTH COMPANY WHOSE LAST DIVIDEND (D0, WHICH WAS PAID YESTERDAY) WAS $2. 00 AND WHOSE DIVIDEND IS EXPECTED TO GROW INDEFINITELY AT A 6 per centum RATE. 1.WHAT IS THE FIRM’S EXPECTED DIVIDEND STREA M everyplace THE NEXT 3 historic period? ANSWER:[SHOW S8-11 HERE. ] BON TEMPS IS A CONSTANT GROWTH STOCK, AND ITS DIVIDEND IS EXPECTED TO GROW AT A CONSTANT RATE OF 6 PERCENT PER YEAR. expressed AS A while LINE, WE HAVE THE FOLLOWING SETUP. JUST ENTER 2 IN YOUR CALCULATOR; THEN observe multiplyING BY 1 + g = 1. 06 TO crap D1, D2, AND D3: 0 1 2 3 | | | | D0 = 2. 00 2. 12 2. 247 2. 382 1. 88 1. 76 1. 65 . . . D. 2. WHAT IS THE FIRM’S CURRENT STOCK PRICE? ANSWER:[SHOW S8-12 HERE. WE COULD EXTEND THE eon LINE ON tabu FOREVER, figure THE VALUE OF BON TEMPS’ DIVIDENDS FOR EVERY YEAR ON OUT INTO THE FUTURE, AND THEN THE PV OF individually DIVIDEND DISCOUNTED AT k = 13%. FOR EXAMPLE, THE PV OF D1 IS $1. 8761; THE PV OF D2 IS $1. 7599; AND SO FORTH. eyeshade THAT THE DIVIDEND PAYMENTS INCREASE WITH TIME, BUT AS LONG AS ks > g, THE PRESENT VALUES decline WITH TIME. IF WE EXTENDED THE GRAPH ON OUT FOREVER AND THEN measureMED THE PVs OF THE DIVIDENDS, WE WOULD HAV E THE VALUE OF THE STOCK. HOWEVER, SINCE THE STOCK IS GROWING AT A CONSTANT RATE, ITS VALUE CAN BE ESTIMATED USING THE CONSTANT GROWTH MODEL: pic] = [pic] = [pic] = [pic] = $30. 29. D. 3. WHAT IS THE STOCK’S EXPECTED VALUE ONE YEAR FROM NOW? ANSWER:[SHOW S8-13 HERE. ] subsequently ONE YEAR, D1 allow HAVE BEEN PAID, SO THE EXPECTED DIVIDEND STREAM WILL THEN BE D2, D3, D4, AND SO ON. THUS, THE EXPECTED VALUE ONE YEAR FROM NOW IS $32. 10: [pic] = [pic] = [pic] = [pic] = $32. 10. D. 4. WHAT ARE THE EXPECTED DIVIDEND brook, THE slap-up GAINS emergence, AND THE replete(p) RETURN DURING THE FIRST YEAR? ANSWER:[SHOW S8-14 HERE. ] THE EXPECTED DIVIDEND founder IN ANY YEAR n IS DIVIDEND matter = [pic], while THE EXPECTED ceiling GAINS issuance IS roof GAINS reelect = [pic] = k †[pic]. THUS, THE DIVIDEND supply IN THE FIRST YEAR IS 7 PERCENT, WHILE THE CAPITAL GAINS YIELD IS 6 PERCENT: summarise RETURN = 13. 0% DIVIDEND YIELD = $2. 12/$30. 29 = 7. 0% CAPITAL GAINS YIE LD = 6. 0% E. NOW ASSUME THAT THE STOCK IS CURRENTLY get byING AT $30. 29. WHAT IS THE EXPECTED RATE OF RETURN ON THE STOCK? ANSWER:THE CONSTANT GROWTH MODEL CAN BE REARRANGED TO THIS FORM: [pic] = [pic]. HERE THE CURRENT PRICE OF THE STOCK IS KNOWN, AND WE SOLVE FOR THE EXPECTED RETURN. FOR BON TEMPS: pic] = $2. 12/$30. 29 + 0. 060 = 0. 070 + 0. 060 = 13%. F. WHAT WOULD THE STOCK PRICE BE IF ITS DIVIDENDS WERE EXPECTED TO HAVE postal code GROWTH? ANSWER:[SHOW S8-15 HERE. ] IF BON TEMPS’ DIVIDENDS WERE NOT EXPECTED TO GROW AT ALL, THEN ITS DIVIDEND STREAM WOULD BE A PERPETUITY. PERPETUITIES ARE VALUED AS SHOWN BELOW: 0 1 2 3 | | | | 2. 00 2. 00 2. 00 1. 77 1. 57 1. 39 . . . P0 = 15. 38 P0 = D/kS = $2. 00/0. 13 = $15. 38. check THAT IF A like STOCK IS A PERPETUITY, IT MAY BE VALUED WITH THIS FORMULA. G.NOW ASSUME THAT BON TEMPS IS EXPECTED TO EXPERIENCE SUPERNORMAL GROWTH OF 30 PERCENT FOR THE NEXT 3 YEARS, THEN TO RETURN TO ITS LONG-RUN CONSTANT GROWTH RATE OF 6 PERCENT. W HAT IS THE STOCK’S VALUE UNDER THESE CONDITIONS? WHAT IS ITS EXPECTED DIVIDEND YIELD AND CAPITAL GAINS YIELD IN YEAR 1? YEAR 4? ANSWER:[SHOW S8-16 through S8-18 HERE. ] BON TEMPS IS NO long-term A CONSTANT GROWTH STOCK, SO THE CONSTANT GROWTH MODEL IS NOT APPLICABLE. NOTE, HOWEVER, THAT THE STOCK IS EXPECTED TO BECOME A CONSTANT GROWTH STOCK IN 3 YEARS. THUS, IT HAS A NONCONSTANT GROWTH PERIOD FOLLOWED BY CONSTANT GROWTH.THE EASIEST WAY TO VALUE SUCH NONCONSTANT GROWTH STOCKS IS TO SET THE power UP ON A TIME LINE AS SHOWN BELOW: 0 1 2 3 4 | | | | | 2. 600 3. 380 4. 394 4. 65764 2. 301 2. 647 3. 045 46. 114 54. 107 SIMPLY ENTER $2 AND engender BY (1. 30) TO pull in D1 = $2. 60; MULTIPLY THAT RESULT BY 1. 3 TO GET D2 = $3. 38, AND SO FORTH. THEN RECOGNIZE THAT AFTER YEAR 3, BON TEMPS BECOMES A CONSTANT GROWTH STOCK, AND AT THAT POINT [pic] CAN BE FOUND USING THE CONSTANT GROWTH MODEL. pic] IS THE PRESENT VALUE AS OF t = 3 OF THE DIVIDENDS IN YEAR 4 AND BEYOND AND IS ALSO C ALLED THE TERMINAL VALUE. WITH THE immediate payment FLOWS FOR D1, D2, D3, AND [pic] SHOWN ON THE TIME LINE, WE DISCOUNT EACH VALUE BACK TO YEAR 0, AND THE SUM OF THESE FOUR PVs IS THE VALUE OF THE STOCK TODAY, P0 = $54. 107. THE DIVIDEND YIELD IN YEAR 1 IS 4. 80 PERCENT, AND THE CAPITAL GAINS YIELD IS 8. 2 PERCENT: DIVIDEND YIELD = [pic] = 0. 0480 = 4. 8%. CAPITAL GAINS YIELD = 13. 00% †4. 8% = 8. 2%. DURING THE NONCONSTANT GROWTH PERIOD, THE DIVIDEND YIELDS AND CAPITAL GAINS YIELDS ARE NOT CONSTANT, AND THE CAPITAL GAINS YIELD DOES NOT EQUAL g.HOWEVER, AFTER YEAR 3, THE STOCK BECOMES A CONSTANT GROWTH STOCK, WITH g = CAPITAL GAINS YIELD = 6. 0% AND DIVIDEND YIELD = 13. 0% †6. 0% = 7. 0%. H. SUPPOSE BON TEMPS IS EXPECTED TO EXPERIENCE ZERO GROWTH DURING THE FIRST 3 YEARS AND THEN TO RESUME ITS STEADY-STATE GROWTH OF 6 PERCENT IN THE FOURTH YEAR. WHAT IS THE STOCK’S VALUE NOW? WHAT IS ITS EXPECTED DIVIDEND YIELD AND ITS CAPITAL GAINS YIELD IN YEAR 1? YEAR 4? ANSWER :[SHOW S8-19 AND S8-20 HERE. ] NOW WE HAVE THIS part: 0 1 2 3 4 | | | | | 2. 00 2. 0 2. 00 2. 00 2. 12 1. 77 1. 57 1. 39 20. 99 25. 72 = [pic] DURING YEAR 1: DIVIDEND YIELD = [pic] = 0. 0778 = 7. 78%. CAPITAL GAINS YIELD = 13. 00% †7. 78% = 5. 22%. AGAIN, IN YEAR 4 BON TEMPS BECOMES A CONSTANT GROWTH STOCK; accordingly g = CAPITAL GAINS YIELD = 6. 0% AND DIVIDEND YIELD = 7. 0%. I. FINALLY, ASSUME THAT BON TEMPS’ stipend AND DIVIDENDS ARE EXPECTED TO DECLINE BY A CONSTANT 6 PERCENT PER YEAR, THAT IS, g = -6%. WHY WOULD ANYONE BE spontaneous TO BUY SUCH A STOCK, AND AT WHAT PRICE SHOULD IT SELL? WHAT WOULD BE THE DIVIDEND YIELD AND CAPITAL GAINS YIELD IN EACH YEAR?ANSWER:[SHOW S8-21 AND S8-22 HERE. ] THE COMPANY IS EARNING SOMETHING AND gainful SOME DIVIDENDS, SO IT CLEARLY HAS A VALUE GREATER THAN ZERO. THAT VALUE CAN BE FOUND WITH THE CONSTANT GROWTH FORMULA, BUT WHERE g IS NEGATIVE: [pic] = [pic] = [pic] = [pic] = [pic] = $9. 89. SINCE IT IS A CONSTANT GROWTH STOCK : g = CAPITAL GAINS YIELD = -6. 0%, thusly: DIVIDEND YIELD = 13. 0% †(-6. 0%) = 19. 0%. AS A CHECK: DIVIDEND YIELD = [pic] = 0. 190 = 19. 0%. THE DIVIDEND AND CAPITAL GAINS YIELDS ARE CONSTANT OVER TIME, BUT A HIGH (19. 0 PERCENT) DIVIDEND YIELD IS require TO OFFSET THE NEGATIVE CAPITAL GAINS YIELD.J. BON TEMPS EMBARKS ON AN AGGRESSIVE EXPANSION THAT REQUIRES ADDITIONAL CAPITAL. MANAGEMENT DECIDES TO FINANCE THE EXPANSION BY adoption $40 MILLION AND BY gamey DIVIDEND PAYMENTS TO INCREASE RETAINED EARNINGS. THE PROJECTED FREE specie FLOWS FOR THE NEXT THREE YEARS ARE -$5 MILLION, $10 MILLION, AND $20 MILLION. AFTER THE THIRD YEAR, FREE CASH FLOW IS PROJECTED TO GROW AT A CONSTANT 6 PERCENT. THE boilers suit COST OF CAPITAL IS 10 PERCENT. WHAT IS BON TEMPS’ perfect VALUE? IF IT HAS 10 MILLION SHARES OF STOCK AND $40 MILLION TOTAL DEBT, WHAT IS THE PRICE PER SHARE? ANSWER:[SHOW S8-23 THROUGH S8-28 HERE. 0 1 2 3 4 | | | | | -5 10 20 21. 20 $ -4. 545 8. 264 15. 026 398. 197 $416. 942 = TOTAL VALUE VALUE OF EQUITY = TOTAL VALUE †DEBT = $416. 94 †$40 = $376. 94 MILLION. PRICE PER SHARE = $376. 94/10 = $37. 69. K. WHAT DOES MARKET equaliser MEAN? ANSWER:[SHOW S8-29 AND S8-30 HERE. ] remainder MEANS STABLE, NO temperament TO CHANGE. MARKET EQUILIBRIUM MEANS THAT PRICES ARE STABLEâ€AT ITS CURRENT PRICE, on that point IS NO GENERAL TENDENCY FOR muckle TO WANT TO BUY OR TO SELL A SECURITY THAT IS IN EQUILIBRIUM.ALSO, WHEN EQUILIBRIUM EXISTS, THE EXPECTED RATE OF RETURN WILL BE EQUAL TO THE REQUIRED RATE OF RETURN: [pic] = D1/P0 + g = k = kRF + (kM †kRF)b. L. IF EQUILIBRIUM DOES NOT EXIST, HOW WILL IT BE found? ANSWER:[SHOW S8-31 AND S8-32 HERE. ] SECURITIES WILL BE BOUGHT AND SOLD UNTIL THE EQUILIBRIUM PRICE IS ESTABLISHED. M. WHAT IS THE EFFICIENT MARKETS HYPOTHESIS, WHAT ARE ITS THREE FORMS, AND WHAT ARE ITS IMPLICATIONS? ANSWER:[SHOW S8-33 THROUGH S8-37 HERE. ] THE EMH IN GENERAL IS THE HYPOTHESIS THAT SECURITIES ARE NORMALLY I N EQUILIBRIUM AND ARE â€Å"PRICED FAIRLY,” MAKING IT IMPOSSIBLE TO â€Å"BEAT THE MARKET. WEAK-FORM faculty SAYS THAT INVESTORS CANNOT PROFIT FROM LOOKING AT early(prenominal) MOVEMENTS IN STOCK PRICESâ€THE FACT THAT STOCKS WENT graduate FOR THE LAST FEW DAYS IS NO REASON TO THINK THAT THEY WILL GO UP (OR DOWN) IN THE FUTURE. THIS FORM HAS BEEN proven PRETTY WELL BY experiential TESTS, EVEN THOUGH PEOPLE pacify EMPLOY â€Å"TECHNICAL ANALYSIS. ” SEMISTRONG-FORM efficiency SAYS THAT ALL PUBLICLY AVAILABLE INFORMATION IS REFLECTED IN STOCK PRICES, HENCE THAT IT WON’T DO MUCH GOOD TO stoma OVER ANNUAL REPORTS TRYING TO regain UNDERVALUED STOCKS.THIS ONE IS (WE THINK) LARGELY TRUE, BUT overlord ANALYSTS CAN STILL OBTAIN AND PROCESS NEW INFORMATION FAST large TO GAIN A SMALL usefulness. STRONG-FORM EFFICIENCY SAYS THAT ALL INFORMATION, EVEN INSIDE INFORMATION, IS enter IN STOCK PRICES. THIS FORM DOES NOT HOLDâ€INSIDERS KNOW MORE, AND COULD TAKE ADV ANTAGE OF THAT INFORMATION TO MAKE ABNORMAL kale IN THE MARKETS. TRADING ON THE theme OF INSIDER INFORMATION IS ILLEGAL. N. PHYFE COMPANY RECENTLY ISSUED favorite(a) STOCK. IT PAYS AN ANNUAL DIVIDEND OF $5, AND THE ISSUE PRICE WAS $50 PER SHARE. WHAT IS THE EXPECTED RETURN TO AN INVESTOR ON THIS PREFERRED STOCK?ANSWER:[SHOW S8-38 AND S8-39 HERE. ] [pic]= [pic] = [pic] = 10%. ———————†ks = 15% gn = 6% ( 1/(1. 15)3 ( 1/(1. 13)3 ( 1/(1. 13)2 ( 1/1. 13 gs = 50% gn = 8% [pic] ks = 12% gs = 15% gn = 5% WACC = 10% [pic] = 30. 29 = [pic] g = 0% g = 0% g = 0% gn = 6% ks = 13% [pic] = $66. 54 = [pic] gs = 30% gs = 30% gs = 30% gn = 6% ks = 13% g = 0% ks = 13% g = 6% ks = 13% ks = 10% gs = 20% gs = 20% gn = 5% WACC = 12% WACC = 12% gn = 7% [pic] WACC = 13% gn = 7% 530 = [pic] ( 1/(1. 15)4 ( 1/(1. 15)5 ks = 12% ( 1/1. 13 ( 1/(1. 13)2 ( 1/(1. 13)3 ( 1/(1. 13)2 ( 1/(1. 13)2 ( 1/1. 13 ( 1/(1. 13)2 ( 1/(1. 13)3 ( 1/(1. 13)3 ( 1/1. 13 ( 1/1. 13 (%89\r \n'