Fin515 Wk4 Homework

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FIN515
Homework WK 4
Problems p.297

(7–2) Constant Growth Valuation
Boehm Incorporated is expected to pay a $1.50 per share dividend at the end of this year (i.e., D1 = $1.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs, is 15%. What is the value per share of Boehm’s stock? (Brigham 297)
Stock Price = $1.50 / (0.15 – 0.07) = $18.75

(7–4) Preferred Stock Valuation
Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return? (Brigham 297)
$5 / $50 = 10%

(7–5) Nonconstant Growth Valuation
A company currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price? (Brigham 297)
The rate of return: r_s=r_RF+(r_M-r_RF )b=7.5%+(4%)1.2=12.3%
Expected Dividends: D0=$2.00 D1=$2.00(1.20)=$2.40 D2=$2.00(1.20)2=$2.88 D3=$2.88(1.07)=$3.08

PV of Expected Dividends:

PVDiv = $2.40/(1.123)+$2.88/(1.123)2=$2.14+$2.28=$4.42

P ̂_2 : P ̂_2= D3 / (rS – g) = $3.08/(0.123 – 0.07) = $58.11
PV of P ̂_2 :

PV = $58.11/(1.123)2 = $46.08

Sum of PVs to obtain stock’s price:

P ̂_0 =$4.42 + $46.08 = $50.50 Problems p. 371

(9-2)
LL Incorporated’s currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL’s after-tax cost of debt? (Brigham 371) rd(1 - T) = 0.08(0.65) = 5.2%

(9-4) Cost of Preferred Stock with…...

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