Sheridan Pharma is a fast-growing drug company. Management forecasts that in the next three years, the company's dividend growth rates will be 30 percent, 28 percent, and 24 percent, respectively. Last week it paida dividend of $1.60. After three years, management expects dividend growth to stabilize at a rate of 8 percent. The required rate of return is 13.50 percent.

Sheridan Pharma is a fast-growing drug company. Management forecasts that in the next three years, the company's dividend growth rates will be 30 percent, 28 percent, and 24 percent, respectively. Last week it paida dividend of $1.60. After three years, management expects dividend growth to stabilize at a rate of 8 percent. The required rate of return is 13.50 percent.

EBK CFIN

6th Edition

ISBN:9781337671743

Author:BESLEY

Publisher:BESLEY

Chapter11: The Cost Of Capital

Section: Chapter Questions

Problem 8PROB

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ALTERNATIVE DIVIDEND POLICIES Rubenstein Bros. Clothing is expecting to pay an annual dividend per share of 0.75 out of annual earnings per share of 2.25. Currently, Rubenstein Bros.' stock is selling for 12.50 per share. Adhering to the company's target capital structure, the firm has 10 million in total invested capital, of which 40% is funded by debt. Assume that the firm's book value of equity equals its market value. In past years, the firm has earned a return on equity (ROE) of 18%, which is expected to continue this year and into the foreseeable future. a. Based on this information, what long-run growth rate can the firm be expected to maintain? (Hint: g = Retention rate ROE.) b. What is the stock's required return? c. If the firm changed its dividend policy and paid an annual dividend of 1.50 per share, financial analysts would predict that the change in policy will have no effect on the firm's stock price or ROE. Therefore, what must be the firms new expected long-run growth rate and required return? d. Suppose instead that the firm has decided to proceed with its original plan of dis bursing 0.75 per share to shareholders, but the firm intends to do so in the form of a stock dividend rather than a cash dividend. The firm will allot new shares based on the current stock price of 12.50. In other words, for every 12.50 in dividends due to shareholders, a share of stock will be issued. How large will the stock dividend be relative to the firm's current market capitalist ion? (Hint. Remember that market capitalization = P0 number of shares outstanding.) e. If the plan in part d is implemented, how many new shares of stock will be issued, and by how much will the companys earnings per share be diluted?
RESIDUAL DIVIDEND MODEL Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a 3.00 dividend per share (DPS) for the past several years, and its, shareholders expect the dividend to remain constant for the next several years. The Companys target capital structure is 60% equity and 40% debt, it has 1,000,000 shares of common equity outstanding, and its net income is 8 million. The company forecasts that it will require 10 million to fund all of its profitable (i.e., positive NPV) projects for the upcoming year. a. If Buena Terra follows the residual dividend model, how much retained earnings will it need to fund its capital budget? b. If Buena Terra follows the residual dividend model, what will be the companys dividend per share and payout ratio for the upcoming year? c. If Buena Terra maintains its current 3.00 DPS for next year, how much retained earnings will be available for the firm's capital budget? d. Can the company maintain its current capital structure, the 3.00 DPS, and a 10 million Capital budget without having to raise new common stock? e. Suppose that Buena Terra's management is firmly opposed to cutting the dividend; that is, it wants to maintain the 3.00 dividend for the next year. Also, assume that the company was committed to funding all profitable projects and was willing to issue more debt (along with the available retained earnings) to help finance the companys capital budget. Assume that the resulting change in capital structure has a minimal effect on the company's composite cost of capital so that the capital budget remains at 10 million. What portion of this year's capital budget would have to be financed with debt? f. Suppose once again that Buena Terras management wants to maintain the 3.00 DPS. In addition, the company wants to maintain its target capital structure (60% equity and 40% debt) and its 10 million capital budget. What is the minimum dollar amount of new common stock that the company would have to issue to meet each of its objectives? g. Now consider the case where Buena Terra's management wants to maintain the 3.00 DPS and its target capital structure, but it wants to avoid issuing new common stock. The company is willing to cut its capital budget to meet its other objectives. Assuming that the company's projects are divisible, what will be the company's capital budget for the next year? h. What actions can a firm that follows the residual dividend model take when its forecasted retained earnings are less than the retained earnings required to fund its capital budget?
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Problem 6-32 Stock Valuation and Cash Flows Anya Manufacturing has projected sales of $116 million next year. Costs are expected to be $67.2 million, and net investment is expected to be $12.6 million. Each of these values is expected to grow at 10 percent the following year, with the growth rate declining by 1 percent per year until the growth rate reaches 6 percent, where it is expected to remain indefinitely. There are 4.9 million shares of stock outstanding and investors require a return of 11 percent on the company’s stock. The corporate tax rate is 22 percent. a. What is your estimate of the current stock price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. Suppose instead that you estimate the terminal value of the company using a PE multiple. The industry PE multiple is 13. What is your new estimate of the company’s stock price? (Do not round intermediate calculations and round your answer to 2 decimal places,…
Problem 9-15 Differential Growth Synovec Company is growing quickly. Dividends are expected to grow at a rate of 22 percent for the next three years, with the growth rate falling off to a constant 7 percent thereafter. If the required return is 12 percent and the company just paid a dividend of $1.30, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Problem 9-17 Negative Growth Antiques R Us is a mature manufacturing firm. The company just paid a dividend of $8.90, but management expects to reduce the payout by 4 percent per year, indefinitely. If you require a return of 14 percent on this stock, what will you pay for a share today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Problem 9-10Cost of Equity The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 3% per year in the future. Shelby's common stock sells for $29.75 per share, its last dividend was $2.00, and the company will pay a dividend of $2.06 at the end of the current year. Using the discounted cash flow approach, what is its cost of equity? Round your answer to two decimal places. % If the firm's beta is 0.6, the risk-free rate is 4%, and the expected return on the market is 13%, then what would be the firm's cost of equity based on the CAPM approach? Round your answer to two decimal places. % If the firm's bonds earn a return of 12%, then what would be your estimate of rs using the over-own-bond-yield-plus-judgmental-risk-premium approach? Round your answer to two decimal places. (Hint: Use the midpoint of the risk premium range.) % On the basis of the results of parts a through c, what would be your estimate of Shelby's cost of equity? Assume Shelby values each…
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