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08.012.0
000,108$
b. 0 1 2 3 N
-20 30 40
c. Total valuet=0 = $527.89 + $10.0 = $537.89.
3
P
ˆ
e.
0
P
ˆ
=
gr
)g1(D
s
0
=
gr
D
s
1
=
06.013.0
59.1$
= $22.71.
f. The value of the stock is not dependent upon the holding period. The value
calculated in Parts a through d is the value for a 3-year holding period. It is equal to
the value calculated in Part e except for a small rounding error. Any other holding
period would produce the same value of
0
P
ˆ
; that is,
0
P
ˆ
= $22.71.
Answers and Solutions: 7- 2
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
7-20 a. End of Year: 0 1 2 3 4 5 6
| | | | | | |
D0 = 1.75 D1 D2 D3 D4 D5 D6
Dt= D0(1 + g)t
D1= $1.75(1.15)1 = $2.01.
b. Step 1
PV of dividends =
5
1t t
s
t
)r1(
D
.
PV D1 = $2.01(PVIF12%,1) = $2.01(0.8929) = $1.79
PV D2 = $2.31(PVIF12%,2) = $2.31(0.7972) = $1.84
Step 2
5
P
ˆ
Answers and Solutions: 7- 3
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
r = 12%
g = 5%
g = 15%
Step 3
The price of the stock today is as follows:
0
P
ˆ
= PV dividends Years 1 through 5 + PV of
5
P
ˆ
This problem could also be solved by substituting the proper values into the following
equation:
0
P
ˆ
=
.
r1
1
gr
D
)r1(
)g1(D
5
1t
5
sns
6
t
s
t
s0
c. First Year (t = 0)
D1/P0 = $2.01/$39.42 = 5.10%
Answers and Solutions: 7- 4
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
Sixth Year (t = 5)
D6/P5 = $3.70/$52.80 = 7.00%
The main points to note here are as follows:
Answers and Solutions: 7- 5
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
7-21 a. Part 1. Graphical representation of the problem:
Nonconstant Normal
growth growth
0 1 2 3 ∞
| | | | |
D0 D1 (D2 +
2
P
ˆ
) D3 D∞
2
P
ˆ
P0
2
P
ˆ
=
ns
3
gr
D
=
ns
n2
gr
)g1(D
=
07.012.0
)06.1( 225.4$
= $90.415.
0
P
ˆ
= PV(D1) + PV(D2) + PV(
2
P
ˆ
)
=
2
s
2
2
s
2
s
1
)r1(
P
ˆ
)r1(
D
)r1(
D
Answers and Solutions: 7- 6
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
Part 2.
1
P
ˆ
and
2
P
ˆ
, discounted for one year.
Second, find the capital gains yield:
b. Due to the longer period of supernormal growth, the value of the stock will be higher
for each year. Although the total return will remain the same, rs = 12%, the
c. Throughout the nonconstant growth period, the total yield will be 12%, but the
Answers and Solutions: 7- 7
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
rises. After the nonconstant growth period has ended, the capital gains yield will
d. Some investors need cash dividends (retired people) while others would prefer
SOLUTION TO SPREADSHEET PROBLEMS
7-22 The detailed solution for the spreadsheet problem, Ch07 P22 Build a Model
Solution.xlsx, is available at the textbook’s Web site.
7-23 The detailed solution for the spreadsheet problem, Ch07 P23 Build a Model
Solution.xlsx, is available at the textbook’s Web site.
7-24 The detailed solution for the spreadsheet problem, Ch07 P24 Build a Model
Solution.xlsx, is available at the textbook’s Web site.
Answers and Solutions: 7- 8
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
MINI CASE
Your employer, a mid-sized human resources management company, is considering
expansion into related fields, including the acquisition of Temp Force Company, an
employment agency that supplies word processor operators and computer programmers to
businesses with temporary heavy workloads. Your employer is also considering the
purchase of Biggerstaff & McDonald (B&M), a privately held company owned by two
friends, each with 5 million shares of stock. B&M currently has free cash flow of $24
million, which is expected to grow at a constant rate of 5%. B&M’s financial statements
report short-term investments of $100 million, debt of $200 million, and preferred stock of
$50 million. B&M’s weighted average cost of capital (WACC) is 11%. Answer the following
questions.
a. Describe briefly the legal rights and privileges of common stockholders.
Answer: The common stockholders are the owners of a corporation, and as such, they have
certain rights and privileges as described below.
2. Common stockholders often have the right, called the preemptive right, to
b. What is free cash flow (FCF)? What is the weighted average cost of capital?
What is the free cash flow valuation model?
Answer: Free cash flow (FCF) is the cash flow available for distribution to all of a company’s
The weighted average cost of capital (WACC) is the overall rate of return required by
Answers and Solutions: 7- 9
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
Vop =
1t t
t
)WACC1(
FCF
Nonoperating assets are marketable securities and ownership of non-controlling
c. Use a pie chart to illustrate the sources that comprise a hypothetical company’s total
value. Using another pie chart, show the claims on a company’s value. How is equity
a residual claim?
Answer: Total corporate value is sum of value of operations and value of nonoperating assets.
Answers and Solutions: 7- 10
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
