Stock

Chapter 9
1. D0 = $1.50
D1 = $1.50(1.07) = $1.605
D2 = $1.50(1.07)2 =$1.7174
D3 = $1.50(1.07)3 =$1.8376
D4 = $1.50(1.07)3(1.05) =$1.9294
D5 = $1.50(1.07)3(1.05)2 = $2.0259
2. D1 = $0.50
rs = 15%
g = 7%
P=?
P = D1/(rs g) = 0.50/(0.15 0.07) = $6.25
3. P = $20
D0 = $1.00
g = 6%
P1 = ?
P1 = P0(1 + g) = $20(1.06) = $21.20
rs = D1/P0 + g = $1.00(1.06)/$20 + 0.06) = 11.3%

rs = ?

4. D0 = $1.25
g = 20% for 2 years, then 5%
rs = 10%
a. The terminal or horizon date is the date when the growth rate becomes constant.
This occurs at the end of year 2.
b. P2 = D3/(rs g) = $1.25(1.20)2(1.1.05)/(0.10 0.05) = $1.89/0.05 = $37.80
c. CF0 = 0
CF1 = $1.25(1.20) = $1.50
CF2 = $1.25(1.20)2 + $37.80 = $1.80 + $37.80 = $39.60
I = 10%
NPV = P0 = $34.09
5. FCF1 = $150,000,000
g = 5%
WACC = 10%
PPS = ?
Firm value = FCF1/(WACC g) = $150,000,000/(0.1 0.05) = $3,000,000,000
PPS = $3,000,000,000/50,000,000 = $60
6. Vp = $60 Dp = $5
rp = ?
rp = Dp/Vp = $5/$60 = 8.33%
7. a.
b.
c.
d.

Dp = $100(0.08) = $8
$8/$80 = 10%
$8/$100 = 8%
$8/$140 = 5.71%

rp = Dp/Vp = $8/$60 = 13.33%

8. Dp = $100(0.10) = $10
rp = 8%
Vp = Dp/rp = $10/0.08 = $125

Vp = ?

9. Vp = $80 Dp = 4($2) = $8
a. Nominal annual rate of return = $8/$80 = 10%

b. EAR = (1 + 0.1/4)4 1 = 10.3813%

10. D0 = $5 rs = 15%
g = -5%
P0 = ?
P0 = $5(1 + -0.05)/(0.15 (-0.05)) = $4.75/0.20 = $23.75
11. D1 = $0.50
g = 7%
rs = 12%
P0 = $0.50/(0.12 0.07) = $10
P4 = = $10(1.07)4 = $13.11

P4 = ?

12. a. rs = 15%
D0 = $2
1. g = -5%
P0 = $2(1 + (-0.05))(0.15 (-0.05)) = $1.90/0.20 = $9.50
2. g = 0%
P0 = $2(1 + 0.0)(0.15 0.0) = $2/0.15 = $13.33
3. g = 5%
P0 = $2(1 + 0.05)(0.15 - 0.05) = $2.10/0.10 = $21.00
4. g = 10%
P0 = $2(1 + 0.10)(0.15 - 0.10) = $2.20/0.05 = $42.00
b. 1. P0 = $2.30/0 = undefined
2. P0 = $2.40/(-0.05) = -$48 which is nonsense.
The formula works only if rs > g.
c. No
13. !C = 0.4 !D = -0.5
rRF = 7%
rm = 11%
a. rC = 7% + 0.4(11% - 7%) = 8.6%
rD = 7% + (-0.5)(11% - 7%) = 5%
b. P0 = $25
D1 = $1.50
g = 4%
rs = ?
rs = $150/$25 + 0.04 = 10%
The stock is not in equilibrium because the expected return is greater than the
return required to compensate for the risk so investors will buy the stock and the
price will increase until the expected return equals the required return.
14. D1 = $2

! = 0.9

rRF = 5.6%

rm - rRF = 6% P0 = $25

Required return = rs = 5.6% + 0.9(6%) = 11%

Find g: rs = D1/P0 + g
0.11 = $2/$25 + g
3
Find P3: P3 = $25(1.03) = $27.32

P3 = ?

g = 3%

rm = 10%
15. ! = 1.5 rRF = 6%
a. D1 = $2.25
g = 5%
P0 = ?
rs = 6% + 1.5(10% - 6%) = 12%
P0 = $2.25/(0.12 0.05) = $32.14
b. rs = 5% + 1.5(9% - 5%) = 11%
P0 = $2.25/(0.11 0.05) = $37.50
c. rs = 5% + 1.5(8% - 5%) = 9.5%
P0 = $2.25/(0.095 0.05) = $50
d. ! = 1.3

rRF = 5%

rm = 8%

D1 = $2.25

g = 6%

P0 = ?

rs = 5% + 1.3(8% - 5%) = 8.9%

P0 = $2.25/(0.089 0.06) = $78.28
g = 50% for 2 years, then 8%
16. D3 = $1.00
D1 = 0
D2 = 0
D3 = $1.00
D4 = $1.00(1.5) = $1.50
D5 = $1.00(1.5)2 = $2.25
D6 = $1.00(1.5)2(1.08) = $2.43

rs = 15%

P0 = ?

P5 = D6/(rs g) = $2.43/(0.15 0.08) = $34.714

CF0 = 0
CF1 = 0
CF2 = 0
CF3 = 1.00
CF4 = 1.50
CF5 = 2.25 + 34.714 = 36.964
P0 = NPV = $19.89

I = 15

17. a. Terminal value = $40(1.07)/(0.13 0.07) = $713.33 million

b. CF0 = 0
CF1 = -20
CF1 = 30
CF1 = 40 + 713.33 = 753.33
I = WACC = 13
NPV = $527.89 million
c. Value of equity = Firm value Value of debt = $527.89 - $100 = $427.89
PPS = $427.89/10 = $42.79