Question

Create an excel file and solve the following problems. 1. Firm ABC has a current market value of $41 per share with earnings of $3.64. What is the present value of its growth opportunities if the required return is 992 Use excel spinners to change required return to 8%, 10%, 11%, and 12%. Record and report present values for each. 2. Firm X pays a current (annual) dividend of $1 and is expected to grow at 20% for two years and then 4 thereafter. If the required rate of return for firm X is 8.5%, what is the intrinsic value of its stock? 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? 4. Firm Y currently pays a dividend of $1.22, which is expected to grow indefinitely at 5%. If the current value of the firm's shares based on constant-growth DDM is $32.03, what is the required rate of return? 5. MM Corp, has an ROE of 16% and a plowback ratio of 50%. If the coming year's earnings are expected to be s2 per share, at what price will the stock sell? The market capitalization rate is 12%. 6. The stock of NN Corporation is currently selling for $10 per share. EPS in the coming year are expected to be 52. The company has a policy of paying out 50% of its earnings each year in dividends. The rest is retained and invested in projects that earn a 20% rate of return per year. This situation is expected to continue indefinitely. a) Assuming the current market price of the stock reflects its intrinsic value as computed using constant-growth DDM, what rate of return do NN Corp's investors require? b) By how much does its value exceed what it would be if all earnings were paid as dividends and nothing was reinvested? C) If NN was to cut is dividend payout ratio to 25%, what would happen to its stock price? d) What if NN eliminated dividends, what would happen to its stock price? 7. The risk-free rate of return is 8%, the expected rate of return on market portfolio is 15%, and the stock of CZ has a beta coefficient of 1.2. XCZ pays out 40% of its earnings as dividends, and the latest earnings announcement were $10 per share. Dividends were just paid and are expected to be paid annually. You expect XCZ to earn an ROE of 20% per year on all reinvested earnings forever a) What is the intrinsic value of XCZ's stock7 b) if the market price of a share is currently $100, and you expect the market price to be equal to intrinsic value one year from now, what is your expected one-year holding period return on XCZ stock?

Questions 1-3

Answer 1

1. Present Value of Growth Opportunities The present value of growth opportunities (PVGO) is the portion of a stock's value that is derived from future growth of dividends. PVGO = Price per share - (Earnings per share/required return rate) PVGO = $ 41 - ($ 3.64/9%) PVGO = $ 0.56 Using Excel Spinners : Market Price per share Earning per share Required Return Rate 3.64 8 Present Value of Growth Opp. 4.50 Using Excel Spinners: Market Price per share Earning per share Required Return Rate 41 3.64 9 Present Value of Growth Opp0.56 41 Using Excel Spinners: Market Price per share Earning per share Required Return Rate 3.64 10 o Present Value of Growth Opp. 4.60 41 Using Excel Spinners : Market Price per share Earning per share Required Return Rate 3.64 11 Present Value of Growth Opp 7.91 Using Excel Spinners : Market Price per share Earning per share Required Return Rate 41 3.64 12 o Present Value of Growth Opp. 10.67 2. Intrinsic Value of the Share Present Value of Dividend (D) (Expan. 1) = $2.33 Price at Year 2 (P2) (Expan. 2) = $ 53.85 Required Rate (K) = 8.5% = 085 Stock Price (PO) = D + (P2/(1+r)^2) Stock Price (PO) = 2.33 +(53.85/(1+085)^2) Stock Price (PO) = 2.33 * 45.74 Stock Price (PO) = $ 48.07 Expan. 1 Calculation of D, i.e. Present Value of Dividends Dividend for Year 1 = $1*(1.2) = $ 1.2 Dividend for Year 2 = $ 1.2* (1.2) = $ 1.44 Present Vale of these Dividends, at 8.5% Present Value of Dividends = {1.2/(1+0.085)-1} + {1.44/(1+0.085)^2) Present Value of Dividends = 1.11 + 1.22 Present Value of Dividends = $ 2.33 Expan. 2 Using Growth Model for calculation of Share Price for Year 2 Dividend (D2) = $ 2.33 Dividend Growth (G) = 4% = 04 Required Rate (K) = 8.5% = 085 Stock Price (P2) = D2 *(1+G)/(K-G) Stock Price (P2) = 2.33 *(1 +0.04)/(0.095 -0.04) Stock Price (P2) = 2.33 * 1.04/0.045 Stock Price (P2) = $ 53.85 2. Relationship Market Capitalisation Rate(K)is the rate of return an investor required to earn on a share based on his risk profile. Intrinsic Value is the True Value of a Share. CAPM: K=Rf + Beta(Rm - Rf Here, K = Market Capitalisation Rate Beta = Beta of the Share Rf= Risk Free Rate Rm= Expected Market Return If the Intrinsic Value matcheswith the Price of the Share, then the Market Capitalisation Rate is equal to the Requried Rate of Return. If the Intrinsic Value > Price of the Share, then the Requried Rate of Return is more than is greater than the Market Capitalisation Rate.