Concept explainers
Valuing Tree cash flow Phoenix Corp. faltered in the recent recession but is recovering.
Phoenix’s recovery will be complete by 2021, and there will be no further growth in free cash flow.
- a. Calculate the PV of free cash flow, assuming a
cost of equity of 9%. - b. Assume that Phoenix has 12 million shares outstanding. What is the price per share?
- c. If the 2016 net income is $1 million, what is Phoenix’s P/R ratio? How do you expect that P/E ratio to change from 2017 to 2021?
- d. Confirm that the expected
rate of return on Phoenix stock is exactly 9% in each of the years from 2017 to 2021.
a)
To determine: Present value of free cash flow
Explanation of Solution
Compute the present value of free cash flow:
Hence, the present value is $26.68 million.
b)
To determine: Price per share
Explanation of Solution
Note:
Assume no debt, the share price are as follows,
Hence, the price per share is $2.04.
c)
To determine: PE ratio and change in PE ratio from 2017 to 2021.
Explanation of Solution
Compute PE ratio:
Compute PV of the cash flows at various points in time:
Changes in PE ratio:
d)
To confirm: The expected rate of return is 9%.
Explanation of Solution
Compute rate of return using the formula
Thus, the above calculation shows that the rate of return on Company P is exactly 9%.
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Chapter 4 Solutions
PRIN.OF CORPORATE FINANCE >BI<
- Dividend Payout The Wei Corporation expects next year’s net income to be $15 million. The firm is currently financed with 40% debt. Wei has $12 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual distribution model (assuming all payments are in the form of dividends), how large should Wei’s dividend payout ratio be next year?arrow_forwardWACC Estimation On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $30 million in new projects. The firm’s present market value capital structure, shown here, is considered to be optimal. There is no short-term debt. New bonds will have an 8% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders’ required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so the dividend yield is $1.20/$30 = 4%.) The marginal tax rate is 40%. In order to maintain the present capital structure, how much of the new investment must be financed by common equity? Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional shares of equity, what is its WACC? Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC? No numbers are required to answer this question.arrow_forwardCALCULATING THE WACC Here is the condensed 2019 balance sheet for Skye Computer Company (in thousands of dollars): Skyes earnings per share last year were 3.20. The common stock sells for 55.00. last years dividend (D0) was 2.10, and a flotation cost of 10% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 9%. Skyes preferred stock pays a dividend of 3.30 per share, and its preferred stock sells for 30.00 per share. The firms before-lax cost of debt is 10%, and its marginal tax rate is 25%. The firms currently outstanding 10% annual coupon rate, long-term debt sells at par value. The market risk premium is 5%, the risk-free rate is 6%, and Skyes beta is 1.516. The firms total debt, which is the sum of the companys short-term debt and long-term debt, equals 1.2 million. a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity. b. Now calculate the cost of common equity from retained earnings, using the CAPM method. c. What is the cost of new common stock based on the CAPM? (Hint: Find the difference between r1 and rs as determined by the DCF method, and add that differential to the CAPM value for rs.) d. If Skye continues to use the same market-value capital structure, what is the firms WACC assuming that (1) it uses only retained earnings for equity and (2) if it expands so rapidly that it must issue new common stock?arrow_forward
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