Chapter 18 Problem Sets Qs 1-6, 8*, 9*, 12,13

Question 1

In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm?

Question 2

In what circumstances is it most important to use multistage dividend discount models rather than constant-growth models?

Question 3

If a security is underpriced (i.e., intrinsic value > price), then what is the relationship between its market capitalization rate and its expected rate of return?

Question 4

Deployment Specialists pays a current (annual) dividend of $1.00 and is expected to grow at 20% for 2 years and then at 4% thereafter. If the required return for Deployment Specialists is 8.5%, what is the intrinsic value of its stock?

Question 5

Jand. Inc., currently pays a dividend of $ 1.22, which is expected to grow indefinitely at 5%. If the current value of Jand's shares based on the constant-growth dividend discount model is $32.03, what is the required rate of return?

Question 6

A firm pays a current dividend of $1.00. which is expected to grow at a rate of 5% indefinitely. If current value of the firm's shares is $35.00, what is the required return based on the constant-growth dividend discount model (DDM)?

Question 8

a. Computer stocks currently provide an expected rate of return of 16%. MBI. a large computer company, will pay a year-end dividend of $2 per share. If the stock is selling at $50 per share, what must be the market's expectation of the dividend growth rate?

b. If dividend growth forecasts for MBI are revised downward to 5% per year, what will happen to the price of MBI stock?

c. What (qualitatively) will happen to the company's price-earnings ratio?

Question 9

a. MF Corp, has an ROE of 16% and a plowback ratio of 50%. If the coming year's earnings are expected to be $2 per share, at what price will the stock sell? The market capitalization rate is 12%.

b. What price do you expect MF shares to sell for in three years?

Question 12

Eagle Products' EBIT is $300, its tax rate is 21%, depreciation is $20, capital expenditures are $60, and the planned increase in net working capital is $30. What is the free cash flow to the firm?

Question 13

FinCorp's free cash flow to the firm is reported as $205 million. The firm's interest expense is $22 million. Assume the corporate tax rate is 21% and the net debt of the firm increases by $3 million. What is the market value of equity if the FCFE is projected to grow at 3% indefinitely and the cost of equity is 12%?

Chapter 18 CFA Problems 1, 3*, 9*, 10*

Problem 1

At Litchfield Chemical Corp. (LCC). a director of the company said that the use of dividend discount models by investors is “proof that the higher the dividend, the higher the stock price.

a. Using a constant-growth dividend discount model as a basis of reference, evaluate the director's statement.

b. Explain how an increase in dividend payout would affect each of the following (holding all other factors constant):

i. Sustainable growth rate.

ii. Growth in book value.

Problem 3

Abbey Naylor, CFA, has been directed to determine the value of Sundanci's stock using the Free Cash Flow to Equity (FCFE) model. Naylor believes that Sundanci's FCFE will grow at 27% for two years and 13% thereafter. Capital expenditures, depreciation, and working capital are all expected to increase proportionately with FCFE.

a. Calculate the amount of FCFE per share for the year 2018, using the data from ® Table 18A.

b. Calculate the current value of a share of Sundanci stock based on the two-stage FCFE model.

c.

i. Describe one limitation of the two-stage DDM model that is addressed by using the two-stage FCFE model.

ii. Describe one limitation of the two-stage DDM model that is not addressed by using the two-stage FCFE model.

Table 18A Sundanci actual 2017 and 2018 financial statements for fiscal years ending May 31 ($ million, except per-share data)

Problem 9*

9. Rio National Corp, is a U.S.-based company and the largest competitor in its industry. ® Tables 18F through 181 present financial statements and related information for the company. © Table 18J presents relevant industiy and market data.

The portfolio manager of a large mutual fund comments to one of the fund's analysts, Katrina Shaar: "We have been considering the purcliase of Rio National Corp, equity shares, so I would like you to analyze the value of the company. To begin, based on Rio National's past performance, you can assume that the company will grow at the same rate as the industry?

a. Calculate the intrinsic value of a share of Rio National equity on December 31, 2020. using the Gordon constant-growth model and the capital asset pricing model.

b. Calculate the sustainable growth rate of Rio National on December 31, 2020. Use 2020 beginning-of-year balance sheet values.

Table 18F Rio National Corp, summary year-end balance sheets (U.S. $ millions)

Table 18J Industry and market data December 31, 2019