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Chapter 9: Stocks and Their Valuation
Learning Objectives
215
Chapter 9
Stocks and Their Valuation
Learning Objectives
After reading this chapter, students should be able to:
◆ Discuss the legal rights of stockholders.
◆ Explain the distinction between a stock’s price and its intrinsic value.
◆ Identify the two models that can be used to estimate a stock’s intrinsic value: the discounted
dividend model and the corporate valuation model.
◆ List the key characteristics of preferred stock, and describe how to estimate the value of preferred
stock.
216
Lecture Suggestions
Chapter 9: Stocks and Their Valuation
Lecture Suggestions
This chapter provides important and useful information on common and preferred stocks. Moreover, the
valuation of stocks reinforces the concepts covered in Chapters 5, 7, and 8, so Chapter 9 extends and
reinforces concepts discussed in those chapters.
DAYS ON CHAPTER: 3 OF 56 DAYS (50-minute periods)
Chapter 9: Stocks and Their Valuation
Answers and Solutions
217
Answers to End-of-Chapter Questions
9-1 a. The average investor of a firm traded on the NYSE is not really interested in maintaining his
or her proportionate share of ownership and control. If the investor wanted to increase his
9-5 A perpetual bond is similar to a no-growth stock and to a share of perpetual preferred stock in
the following ways:
9-6 The discounted dividend model uses the firm’s cost of equity as the discount rate to discount
future dividends per share an investor expects to receive starting at t = 1 to calculate the firm’s
218
Answers and Solutions
Chapter 9: Stocks and Their Valuation
9-7 The P/E approach can be used as a starting point in stock valuation. If a stock’s P/E ratio is well
above its industry average and if the stock’s growth potential and risk are similar to other firms in
Chapter 9: Stocks and Their Valuation
Answers and Solutions
219
Solutions to End-of-Chapter Problems
9-1 D0 = $1.50; g1-3 = 7%; gn = 5%; D1 through D5 = ?
9-2 D1 = $0.50; g = 7%; rs = 15%;
0
P
ˆ
= ?
9-3 P0 = $20; D0 = $1.00; g = 6%;
1
P
ˆ
= ?; rs = ?
9-4 a. The horizon date is the date when the growth rate becomes constant. This occurs at the end
220
Answers and Solutions
Chapter 9: Stocks and Their Valuation
9-5 The firm’s free cash flow is expected to grow at a constant rate, hence we can apply a constant
growth formula to determine the total value of the firm.
9-6 Dp = $5.00; Vp = $60; rp = ?
9-7 Vp = Dp/rp; therefore, rp = Dp/Vp.
Chapter 9: Stocks and Their Valuation
Answers and Solutions
221
9-9 a. The preferred stock pays $8 annually in dividends. Therefore, its nominal rate of return would
be:
9-11 First, solve for the current price.
9-12 a. 1.
.50.9$
20.0
90.1$
05.015.0
)05.01(2$
P
ˆ
0==
+
−
=
222
Answers and Solutions
Chapter 9: Stocks and Their Valuation
9-13 The problem asks you to determine the value of
3
P
ˆ
, given the following facts: D1 = $2, b = 0.9, rRF =
5.6%, RPM = 6%, and P0 = $25. Proceed as follows:
Step 1: Calculate the required rate of return:
9-14 Calculate the dividend cash flows and place them on a time line. Also, calculate the stock price at the
D0 = 0; D1 = 0; D2 = 0; D3 = 1.00; D4 = 1.00(1.5) = 1.5; D5 = 1.00(1.5)2 = 2.25; D6 =
1.00(1.5)2(1.08) = $2.43.
0
P
ˆ
= ?
Chapter 9: Stocks and Their Valuation
Answers and Solutions
223
9-16 The value of any asset is the present value of all future cash flows expected to be generated from the
asset. Hence, if we can find the present value of the dividends during the period preceding long-run
224
Answers and Solutions
Chapter 9: Stocks and Their Valuation
9-17 0 1 2 3 4
| | | | |
D0 = 2.00 D1 D2 D3 D4
3
P
ˆ
9-18 a. Part 1: Graphical representation of the problem:
rs = 12%
g = 5%
Chapter 9: Stocks and Their Valuation
Answers and Solutions
225
Capital gains yield: First, find
1
P
ˆ
, which equals the sum of the present values of D2 and
2
P
ˆ
discounted for one year.
c. Throughout the supernormal growth period, the total yield, rs, will be 10%, but the dividend
dividend yield must equal 10% – 6% = 4%.
9-19 a. 0 1 2 3 4
WACC = 12%
226
Answers and Solutions
Chapter 9: Stocks and Their Valuation
b. The firm’s horizon value is calculated as follows:
c. The firm’s total value is calculated as follows:
0 1 2 3 4 5
d. To find Barrett’s stock price, you need to first find the value of its equity. The value of Barrett’s
equity is equal to the value of the total firm less the market value of its debt and preferred
stock.
9-20 FCF1 = EBIT(1 – T) + Depreciation –
esexpenditur
Capital
–
capital work ing
operatingNet
WACC = 12%
Chapter 9: Stocks and Their Valuation
Answers and Solutions
227
9-21 a. End of Year: 15 16 17 18 19 20 21
| | | | | | |
b. Step 1:
PV of dividends =
=+
5
1t
t
s
t
)r1(
D
.
Step 2:
rs = 12%
228
Answers and Solutions
Chapter 9: Stocks and Their Valuation
c. 2016
Chapter 9: Stocks and Their Valuation
Comprehensive/Spreadsheet Problem
229
Comprehensive/Spreadsheet Problem
Note to Instructors:
The solution for part a of this problem is provided at the back of the text; however, the
solutions to parts b through d are not. Instructors can access the
Excel
file on the textbook’s
website.
9-22 a. 1. Find the price today.
2. Find the expected dividend yield.
3. Find the expected capital gains yield.
230
Comprehensive/Spreadsheet Problem
Chapter 9: Stocks and Their Valuation
b. 1. Find the price today.
2. Find the expected dividend yield.
3. Find the expected capital gains yield.
Cap. gain yield = Expected total return −
Dividend yield
D0$1.60
