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Constant Growth
Multiple growth model Intrinsic Value & Market price
Treasuries
Corporates Equities Preferred Stock Common Stock
Common Stock
It is an equity ownership in a corporation, initially issued to raise capital Points to keep in mind!
C/Fs are NOT known in advance Life of stocks is forever no maturity
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Discounted Cash flow techniques Attempts to estimate the value of a stock today using a present value analysis. Relative valuation techniques A stock is valued relative to other stocks based on the basis of ratios.
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Key difference!
Estimate the amount & timing of future stream of Cash flows. Estimate an appropriate Discount Rate Use these two components in PV Model to estimate the value of the security, which is then compared to the current Market Price of the security.
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Value the Equity of the Firm, using the required rate of Return to shareholders. Value the entire firm using the Weighted Average Cost of Capital (WACC).
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Investors must value a stream of dividends that may be paid forever, since common stock has no maturity value.
The dividend Stream is uncertain:
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There is no specified number of dividends, if in fact any are paid at all. Dividends are Expected to grow in most cases.
The Zero Growth rate Case The Constant Growth rate Case The Multiple Growth rate Case
A Dividend Stream resulting from Fixed dollar Dividend equal to the current Dividend, Do.
So,
Value of the stock is a Present value of a Perpetuity!
Po = D/K
Which implies:
If dividend just paid is Do, then the next D1 is: D1 D2 = Do*(1+g) = D1*(1+g) = [Do*(1+g)] * (1+g) = Do *(1+g)2 Dividend for period 2, D2:
Po
OR P0
= Do *(1+g) / (K-g)
= D1 / (K g)
Dividend paying stock Required Return by investors is greater than the Growth Rate of Dividends. Dividends will grow at a constant Rate forever.
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& in 4 years?
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0 | 1.00 P0 = ? CFt 0
k = 12% gs = 5%
1 | 1.05 1.05
Time line: 0 2 3 4 Years k = 10% 1 | | | | | g1 = 4% g2 = 5% g3 = 6% gn = 7% 2.00 2.08 2.1840 2.31504 2.4770928 P0 = ? 2.4770928 P = 82.56976 = 0.10 0.07 CFt 0 2.08 2.1840 84.88480
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Assignment (7 Questions)
Q1:A stock is expected to pay $0.45 dividend at the end of the year. The dividend is expected to grow at a constant rate of 4 percent a year, and the stocks required rate of return is 11 percent. What is the expected price of the stock 10 years from today?
Q#2
A stock that currently trades for $40 per share is expected to pay a year-end dividend of $2 per share. The dividend is expected to grow at a constant rate over time. The stock has a required rate of return of 11%. What is the stocks expected price seven years from today?
Q#3
Motor Homes Inc. (MHI) is presently in a stage of abnormally high growth because of a surge in the demand for motor homes. The company expects earnings and dividends to grow at a rate of 20 percent for the next 4 years, after which time there will be no growth (g = 0) in earnings and dividends. The companys last dividend was $1.50. MHIs required return on stock is 18%. What should be the current common stock price?
Q#4
A stock is not expected to pay a dividend over the next four years. Five years from now, the company anticipates that it will establish a dividend of $1.00 per share. Once the dividend is established, the market expects that the dividend will grow at a constant rate of 5 percent per year forever.. The required rate of return on the companys stock is expected to remain constant at 12%. What is the current stock price?
Q#5
R. E. Lee recently took his company public through an initial public offering. He is expanding the business quickly to take advantage of an otherwise unexploited market. Growth for his company is expected to be 40 percent for the first three years and then he expects it to slow down to a constant 15 percent. The most recent dividend (D0) was $0.75. Based on the most recent returns, his companys required return is 20%. What is the current price of Lees stock?
Q#6
DAAs stock is selling for $15 per share. The firms income, assets, and stock price have been growing at an annual 15 percent rate and are expected to continue to grow at this rate for 3 more years. Dividend of $0.50 has been declared recently. After super normal growth, dividends are expected to grow at the firms normal growth rate of 6 percent. The firms required rate of return is 18 percent. Determine whether the stock is under or overvalued. State reasons for your answer!
Q#7
Philadelphia Corporations stock recently paid a dividend of $2.00 per share (D0 = $2), and the stock is in equilibrium. The company has a constant growth rate of 5 percent. The required rate of return on its stock is 29.5%. Philadelphia is considering a change in policy that will increase its required return to 33.25%. If market conditions remain unchanged, what new constant growth rate will cause Philadelphias common stock price to remain unchanged?
Dividend Discount Model Free Cash Flow to Equity (FCFE) Model Free Cash Flow to Firm (FCFF) Model
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Projected NI for the next year $300 million. Projected depreciation expense for the next year $50 million. Projected capital expenditures for the next year $100 million. Projected increase in operating working capital next year $60 million. Interest Expense for the year was $5 million & Company paid back 50 Million of its debt outstanding but also issued $4 million of new debt. Cost of equity 13%. Number of shares outstanding today 20 million. The companys free cash flow is expected to grow at a constant rate of 12% for two years & then will grow at 6%forever. What is the stocks intrinsic value today?
Forecast Expected FCFF Estimate the Discount Rate (WACC) Calculate the Value of the Corporation Calculate Intrinsic Stock Value = Value of Corporation MINUS Value of Debt MINUS Value of Preferred Stock.
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Today is December 31, 2003. The following information applies to Addison Airlines: After-tax, operating income [EBIT(1 - T)] for the year 2004 is expected to be $400 million. The companys depreciation expense for the year 2004 is expected to be $80 million. The companys capital expenditures for the year 2004 are expected to be $160 million. No change is expected in the companys net operating working capital. The companys free cash flow is expected to grow at a constant rate of 5 percent per year. The companys WACC is 10 percent. The current market value of the companys debt is $1.4 billion. The company currently has 125 million shares of stock outstanding.
Step 2:Calculate the firm value today using the constant growth corporate value model: V0 = FCFF1 / (WACC G) = 320 / (0.10 0.05) = 6,400 Million
Divide by the number of shares to find the current price per share:
$5,000 million/125 million = $40.00.
K = (D1/ Po) + g
Assignment # 9 (6 Questions)
Q1: ABC Co. recently had FCFE of $120 Million. Company had 50,000 Bonds outstanding trading @ par with a Coupon Rate of 8%. Capital Expenditure & Change in Working Capital during the year were 15 Million & 5Million, respectively. Company had Depreciation & Amortization charges of 2 Million & 0.5 Million, Respectively. XYZ Co. has a tax rate of 35% with Cost of equity of 12% & WACC equivalent to 10%. No debt outstanding was paid during the year. Although, company issued new bonds worth of 1 million. Company has 500,000 shares of preferred stock outstanding with a par of $120 & dividend rate of 5%. Company is expected to grow at a constant rate of 5% forever. With the given information, calculate Value of the firm & intrinsic value per share using FCFF Model assuming 1 million Common Stock shares outstanding.
Assignment # 9 (6 Questions)
Q2: ABC Co. recently had EBIT of $100 Million. Company had 20,000 Bonds outstanding trading @ par with a Coupon Rate of 7%. Capital Expenditure & Change in Working Capital during the year were 5 Million & 1Million, respectively. Company had Depreciation & Amortization charges of 2.5 Million & 1.5 Million, Respectively. XYZ Co. has a tax rate of 35% with Cost of equity of 12% & WACC equivalent to 9%. Company is expected to grow at a constant rate of 7% forever. With the given information, calculate Value of the firm & intrinsic value per share using FCFF Model assuming 1.5 million shares of common stock outstanding.
Assignment # 9 (6 Questions)
Q3:An analyst has collected the following information about XYZ Co.: Projected NI for the next year $200 million. Projected depreciation expense for the next year $10 million. Projected capital expenditures for the next year $65 million. Projected increase in operating working capital next year $30 million. Interest Expense for the year was $2.5 million & Company paid back 20 Million of its debt outstanding but also issued $4 million of new debt. Cost of equity 12%. Number of shares outstanding today 20 million.
Assignment # 9 (6 Questions)
Q3:
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The companys free cash flow to firm is expected to grow at 15% for first two years, then @ 10% for year 3 & year 4 & then it will grow @ 5% forever. What is the stocks intrinsic value today using FCFF Model? The companys free cash flow to Equity is expected to grow at 10% for first two years, then @ 8% for year 3 & then it will grow @ 5% forever. What is the stocks intrinsic value today using FCFE Model?
Assignment # 9 (6 Questions)
Q4:
The analyst has estimated the companys free cash flows for the following years: Year Free Cash Flow 1 $3,000 2 4,000 3 5,000
The analyst estimates that after three years (t = 3) the companys free cash flow will grow at a constant rate of 6 percent per year. The analyst estimates that the companys weighted average cost of capital is 10 percent. The companys debt and preferred stock has a total market value of $25,000 and there are 1,000 outstanding shares of common stock. What is the (per-share) intrinsic value of the companys common stock?
Assignment # 9 (6 Questions)
Q5: Lamonica Motors just reported earnings per share of $2.00. The stock has a price earnings ratio of 40, so the stocks current price is $80 per share. Analysts expect that one year from now the company will have an EPS of $2.40, and it will pay its first dividend of $1.00 per share. The stock has a required return of 10 percent. What price earnings ratio must the stock have one year from now so that investors realize their expected return?
Assignment # 9 (6 Questions)
Q6: Dean Brothers Inc. recently reported net income of $1,500,000. The company has 300,000 shares of common stock, and it currently trades at $60 a share. The company continues to expand and anticipates that one year from now its net income will be $2,500,000. Over the next year the company also anticipates issuing an additional 100,000 shares of stock, so that one year from now the company will have 400,000 shares of common stock. Assuming the companys price/earnings ratio remains at its current level, what will be the companys stock price one year from now?