7-17 a. HV2 =
08.012.0
000,108$
= $2,700,000.
b. 0 1 2 3 N
| | | | |
$80,000 $100,000 $108,000
)07.1( 40$
3
op
0.10
WACC = 12%
g = 8%
7-19 0 g=6% 1 2 3 4
| | | | |
D0 = 1.50 D1 D2 D3 D4
3
P
ˆ
a. D1 = $1.5(1.06) = $1.59. D2 = $1.50(1.06)2 = $1.69. D3 = $1.5(1.06)3 = $1.79.
b. PV = $1.59(0.8850) + $1.69(0.7831) + $1.79(0.6930) = $3.97.
Calculator solution: Input 0, 1.59, 1.69, and 1.79 into the cash flow register, input
I/YR = 13, PV = ? PV = $3.97.
c. $27.05(0.6930) = $18.74.
Calculator solution: Input 0, 0, 0, and 27.05 into the cash flow register, I/YR = 13,
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.
D2 = $1.75(1.15)2 = $1.75(1.3225) = $2.31.
D3 = $1.75(1.15)3 = $1.75(1.5209) = $2.66.
D4 = $1.75(1.15)4 = $1.75(1.7490) = $3.06.
D5 = $1.75(1.15)5 = $1.75(2.0114) = $3.52.
b. Step 1
PV of dividends =
5
1t t
s
t
)r1(
D
.
Step 2
ns
)n5
ns
6
5gr
g1(D
gr
D
P
ˆ
=
05.012.0
)05.1(52.3$
=
07.0
70.3$
= $52.80.
This is the price of the stock 5 years from now. The PV of this price, discounted back
5 years, is as follows:
PV of
5
P
ˆ
= $52.80(PVIF12%,5) = $52.80(0.5674) = $29.96.
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
= $9.46 + $29.96 = $39.42.
r = 12%
g = 5%
g = 15%
or in part.
This problem could also be solved by substituting the proper values into the following
0
r1
gr
)r1(
1t
sns
t
s
Calculator solution: Input 0, 2.01, 2.31, 2.66, 3.06, 56.32 (3.52 + 52.80) into the cash
flow register, input I/YR = 12, PV = ? PV = $39.43.
c. First Year (t = 0)
D1/P0 = $2.01/$39.42 = 5.10%
*We know that r is 12%, and the dividend yield is 5.10%; therefore, the capital gains
yield must be 6.90%.
The main points to note here are as follows:
1. The total yield is always 12% (except for rounding errors).
Answers and Solutions: 7- 15
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∞
PVD1
PVD2
PV
2
P
ˆ
P0
D1 = D0(1 + gs) = $2.50(1.30) = $3.25.
D2 = D0(1 + gs)2 = $2.50(1.30)2 = $4.225.
2
P
ˆ
=
ns
3
gr
D
=
ns
n2 gr
)g1(D
=
07.012.0
)06.1( 225.4$
= $90.415.
ˆ
2
s
2
s
s
)r1(
)r1(
)r1(
= $3.25(0.8929) + $4.225(0.7972) + $90.415(0.7972) = $78.35.
Part 2.
Expected dividend yield: D1/P0 = $3.25/$78.35 = 4.15%.
ˆ
2
or in part.
d. Some investors need cash dividends (retired people) while others would prefer
or in part.
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.
Mini Case: 7 – 19
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.
b. What is free cash flow (FCF)? What is the weighted average cost of capital?
What is the free cash flow valuation model?
Mini Case: 7 – 20
or in part.
Vop =
1t t
t
)WACC1(
FCF
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?