A
To calculate: The required
Introduction: The required rate of return can be defined as the amount which is expected by the investor out of the investment.
The intrinsic value of the company can be called as the actual worth of the company which includes tangible and intangible factors.
B
To calculate: The intrinsic value by using the table and the two-stage
o be.
Introduction: The required rate of return can be defined as the amount which is expected by the investor out of the investment.
The intrinsic value of the company can be called as the actual worth of the company which includes tangible and intangible factors.
C
To calculate: It is to be determined based on the comparison of the company’s intrinsic value with the current market price which the company will be recommended.
Introduction:
The required rate of return can be defined as the amount which is expected by the investor out of the investment.
The intrinsic value of the company can be called the actual worth of the company which includes tangible and intangible factors.
D
To calculate: The one strength of the two stages DDM is to be described.
Introduction:
The required rate of return can be defined as the amount which is expected by the investor out of the investment.
The intrinsic value of the company can be called the actual worth of the company which includes tangible and intangible factors.
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Chapter 18 Solutions
INVESTMENTS (LOOSELEAF) W/CONNECT
- A group of investors is intent on purchasing a publicly traded company and wants to estimate the highest price they can reasonably justify paying. The target company’s equity beta is 1.20 and its debt-to-firm value ratio, measured using market values, is 60 percent. The investors plan to improve the target’s cash flows and sell it for 12 times free cash flow in year five. Projected free cash flows and selling price are as follows. ($ millions) Year 1 2 3 4 5 Free cash flows $38 $53 $58 $63 $ 63 Selling price $ 756 Total free cash flows $38 $53 $58 $63 $ 819 To finance the purchase, the investors have negotiated a $530 million, five-year loan at 8 percent interest to be repaid in five equal payments at the end of each year, plus interest on the declining balance. This will be the only interest-bearing debt outstanding after the acquisition. Selected Additional Information Tax rate 40 percent Risk-free interest rate 3 percent Market risk…arrow_forwardA group of investors is intent on purchasing a publicly traded company and wants to estimate the highest price they can reasonably justify paying. The target company’s equity beta is 1.20 and its debt-to-firm value ratio, measured using market values, is 60 percent. The investors plan to improve the target’s cash flows and sell it for 12 times free cash flow in year five. Projected free cash flows and selling price are as follows. ($ millions) Year 1 2 3 4 5 Free cash flows $38 $53 $58 $63 $ 63 Selling price $ 756 Total free cash flows $38 $53 $58 $63 $ 819 To finance the purchase, the investors have negotiated a $530 million, five-year loan at 8 percent interest to be repaid in five equal payments at the end of each year, plus interest on the declining balance. This will be the only interest-bearing debt outstanding after the acquisition. Selected Additional Information Tax rate 40 percent Risk-free interest rate 3 percent Market risk…arrow_forwardHamiln Steel Company wishes to determine the value of Craft Foundry, a firm that it is considering acquiring for cash. Hamlin wishes to determine the applicable discount rate to use as an input to the constant-growth valuation model. Craft's stock is not publicly traded. After studying the required returns of firms similar to Craft that are publicly traded, Hamlin believes that an appropriate risk premium on Craft stock is about 8%. The risk-free rate is currently 5%. Craft's dividend per share for each of the past 6 years is shown in the following table. Year Dividend per Share 2019 $3.31 2018 $3.07 2017 $2.84 2016 $2.63 2015 $2.44 2014 $2.26 a. Given that Craft is expected to pay a dividend of $3.58 next year, determine the maximum cash price that Hamlin should pay for each share of Craft. b. Describe the effect on the resulting value of Craft from: (1) A decrease in its dividend growth rate of 2% from that exhibited over the 2014-2019 period. (2) A decrease…arrow_forward
- The Carpetto’s stock currently sells for $23 per share, will pay a dividend of $2.14 at the end ofthe current year, and the dividend is expected to grow at 7 percent per year in the future.a. Using the DDM approach, what is its cost of common equity?b. If the firm’s beta is 1.6, the risk-free rate is 9 percent, and the average return on themarket is 13 percent, what will be the firm’s cost of common equity using the CAPMapproach?c. If the estimated cost of equity is not the same using the CAPM and DDM approaches,how we can decide on the proper value for cost of equity? Explain.arrow_forwardYou have assigned the following values to these three firms: Price Upcoming Dividend Growth Beta US Bancorp $ 51.35 $ 2.25 7.00 % 1.78 Praxair 41.60 1.55 20.50 1.96 Eastman Kodak 43.15 2.00 8.40 0.84 Assume that the market portfolio will earn 11.00 percent and the risk-free rate is 4.00 percent. Compute the required return for each company using both CAPM and the constant-growth model. (Do not round intermediate calculations and round your final answers to 2 decimal places.) CAPM Constant-Growth Model US Bancorp required return % % Praxair required return % % Eastman Kodak required return % %arrow_forwardThe Carpetto’s stock currently sells for $23 per share, will pay a dividend of $2.14 at the end of the current year, and the dividend is expected to grow at 7 percent per year in the future. Using the DDM approach, what is its cost of common equity? If the firm’s beta is 1.6, the risk-free rate is 9 percent, and the average return on the market is 13 percent, what will be the firm’s cost of common equity using the CAPM approach? If the estimated cost of equity is not the same using the CAPM and DDM approaches, how we can decide on the proper value for cost of equity? Explain.arrow_forward
- An investor with a required return of 14 percent for very risky investment in common stock has analyzed three firms and must decide which, if any, to purchase firm A B C current earnings $2.00 $3.20 $7.00 current dividend $1.0 $3.00 $7.50 expected annual growth rate in 7% 2% -1% dividends and earnings Current market price $23 $47 $60 what is the maximun price that investor should pay for each stock based on the dividend growth model? b. if the investor does buy stock A, what is the implied percentage return? c. if the appropiate P/E ratio is 12, what is the maximun price the investor should pay for each stock? would your answer be differeny if the appropiate P/E were 7? d. what…arrow_forwardYou are told by your investment advisor that Laduma Co. is expected to earn R5 per share next year, R6 per share the following year and that thereafter earnings are expected to grow by 8% per year. The dividend payout ratio is 60% and the required rare or return on Laduma shares is 15%. If the current share price is R40, would you expect your adviser to make a buy, hold or sell recommendation? If transaction costs are R2,50 per share, would you follow his advice?arrow_forwardYou are the investment manager for Global Assets Investments Company's mutual fund and you have US$690,000,000.00 to invest in Fidelity Co. ltd, a stock selling for US$46 per share. The initial margin requirement is 60%, and the maintenance margin is 40%. Show in detail the impact on your rate of return if the stock rises to US$57 per share and if it declines to US$19 per share assuming: (i) you pay cash for the stock (ii) you buy it using maximum leverage (B) Based on further market analysis you believe that the stock price of another company, Tower Equity Co. Ltd, may rise shortly and you have US$470,000 to open a second margin account to purchase Tower Equity's shares at US$23.50 per share. Assuming the initial margin requirement is 55%; (i) how many shares can you purchase using maximum allowable margin (ii) if the maintenance margin is 35% to what price can Tower Equity Co. Ltd stock fall before you receive a margin call (iii) one month later the stock falls to US$8 per share and…arrow_forward
- Hamlin Steel Company wishes to determine the value of Craft Foundry, a firm that it is considering acquiring for cash. Hamlin wishes to determine the applicable discount rate to use as an input to the constant-growth valuation model. Craft's stock is not publicly traded. After studying the required returns of firms similar to Craft that are publicly traded, Hamlin believes that an appropriate risk premium on Craft stock is about 9%.The risk-free rate is currently 4%. Craft's dividend per share for each of the past 6 years is shown in the following table: a. Given that Craft is expected to pay a dividend of $3.87 next year, determine the maximum cash price that Hamlin should pay for each share of Craft. (Hint: Round the growth rate to the nearest whole percent.) b. Describe the effect on the resulting value of Craft from: (1) A decrease in its dividend growth rate of 2% from that exhibited over the 2017-2022 period. (2) A decrease in its risk premium to 8%.arrow_forwardExpress Steel Corporation wishes to calculate its cost of common stock equity, by using the capital asset pricing model (CAPM). The firm’s investment advisors and its own analysts indicate that the risk-free rate equals 9,1%; the firm’s beta equals 0,75; and the market return equals 16%. Please estimate the cost of common stock equity by using CAPM.arrow_forwardYou are told by your investment advisor that Ladumo Co. is expected to earn R5 per share next year, R6 per share the following year and that thereafter earnings are expected to grow by 8% per year. The dividend payout ratio is 60% and the required rate of return on Ladumo shares is 15%. If the current share price is R40, would you expect your advisor to make a buy, hold or sell recommendation? If transaction costs are R2.50 per share, would you follow his advice?arrow_forward
- Financial Reporting, Financial Statement Analysis...FinanceISBN:9781285190907Author:James M. Wahlen, Stephen P. Baginski, Mark BradshawPublisher:Cengage Learning