Chapter 18 – Equity Valuation Models
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122. Smart Draw Company is expected to have per share FCFE in year 1 of $1.20, per share
FCFE in year 2 of $1.50, and per share FCFE in year 3 of $2.00. After year 3, per share FCFE
is expected to grow at the rate of 10% per year. An appropriate required return for the stock is
14%. The stock should be worth _______ today.
A. $33.00
Calculations are shown in the table below.
Difficulty: Difficult
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123. Old Style Corporation produces goods that are very mature in their product life cycles.
Old Style Corporation is expected to have per share FCFE in year 1 of $1.00, per share FCFE
of $0.90 in year 2, and per share FCFE of $0.85 in year 3. After year 3, per share FCFE is
expected to decline at a rate of 2% per year. An appropriate required rate of return for the
stock is 8%. The stock should be worth ______.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
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124. Goodie Corporation produces goods that are very mature in their product life cycles.
Goodie Corporation is expected to have per share FCFE in year 1 of $2.00, per share FCFE of
$1.50 in year 2, and per share FCFE of $1.00 in year 3. After year 3, per share FCFE is
expected to decline at a rate of 1% per year. An appropriate required rate of return for the
stock is 10%. The stock should be worth ______.
Difficulty: Difficult
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125. The growth in per share FCFE of SYNK, Inc. is expected to be 8%/year for the next two
years, followed by a growth rate of 4%/year for three years; after this five year period, the
growth in per share FCFE is expected to be 3%/year, indefinitely. The required rate of return
on SYNC, Inc. is 11%. Last year’s per share FCFE was $2.75. What should the stock sell for
today?
Difficulty: Difficult
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126. The growth in per share FCFE of FOX, Inc. is expected to be 15%/year for the next three
years, followed by a growth rate of 8%/year for two years; after this five year period, the
growth in per share FCFE is expected to be 3%/year, indefinitely. The required rate of return
on FOX, Inc. is 13%. Last year’s per share FCFE was $1.85. What should the stock sell for
today?
Difficulty: Difficult
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129. Fly Boy Corporation is expected have EBIT of $800k this year. Fly Boy Corporation is
in the 30% tax bracket, will report $52,000 in depreciation, will make $86,000 in capital
expenditures, and have a $16,000 increase in net working capital this year. What is Fly Boy’s
FCFF?
Difficulty: Moderate
130. Lamm Corporation is expected have EBIT of $6.2M this year. Lamm Corporation is in
the 40% tax bracket, will report $1.2M in depreciation, will make $1.4M in capital
expenditures, and have a $160,000 increase in net working capital this year. What is Lamm’s
FCFF?
Difficulty: Moderate
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131. Rome Corporation is expected have EBIT of $2.3M this year. Rome Corporation is in
the 30% tax bracket, will report $175,000 in depreciation, will make $175,000 in capital
expenditures, and have no change in net working capital this year. What is Rome’s FCFF?
Difficulty: Moderate
Chapter 18 – Equity Valuation Models
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Short Answer Questions
132. Discuss the Gordon, or constant discounted dividend, model of common stock valuation.
Include in your discussion the advantages, disadvantages, and assumptions of the model.
The Gordon model discounts the expected dividends for the coming year by the required rate
of return on the stock minus the growth rate. The growth rate is annual growth in dividends,
and is assumed to be a constant annual growth rate indefinitely. Obviously such an
Difficulty: Moderate
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135. Describe the free cash flow approach to firm valuation. How does it compare to the
dividend discount model (DDM)?
Difficulty: Moderate