# Woidtke Manufacturing’s stock currently sells - Expert Answers

Woidtke Manufacturing’s stock currently sells for $22 a share. The stock just paid a dividend of $1.20 a share (i.e., D0 = $1.20), and the dividend is expected to grow forever at a constant rate of 10% a year. What stock price is expected 1 year from now? What is the estimated required rate of return on Woidtke’s stock (assume the market is in equilibrium with the required return equal to the expected return)?

Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return (assume the market is in equilibrium with the required return equal to the expected return)? A company currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price?

Crisp Cookware’s common stock is expected to pay a dividend of $3 a share at the end of this year (D1 = $3.00); its beta is 0.8; the risk-free rate is 5.2%; and the market risk premium is 6%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $40 a share. Assuming the market is in equilibrium, what does the market believe will be the stock’s price at the end of 3 years (i.e., what is P3 Assume that the average firm in your company’s industry is expected to grow at a constant rate of 6% and that its dividend yield is 7%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 = D0(1 + g) = D0(1.50)] this year and 25% the following year, after which growth should return to the 6% industry average. If the last dividend paid (D0) was $1, what is the estimated value per share of your firm’s stock? Simpkins Corporation does not pay any dividends because it is expanding rapidly and needs to retain all of its earnings. However, investors expect Simpkins to begin paying dividends, with the first dividend of $0.50 coming 3 years from today. The dividend should grow rapidly—at a rate of 80% per year—during Years 4 and 5. After Year 5, the company should grow at a constant rate of 7% per year. If the required return on the stock is 16%, what is the value of the stock today (assume the market is in equilibrium with the required return equal to the expected return)? Several years ago, Rolen Riders issued preferred stock with a stated annual dividend of

10% of its $100 par value. Preferred stock of this type currently yields 8%. Assume dividends are paid annually.

a. What is the estimated value of Rolen’s preferred stock?

b. Suppose interest rate levels have risen to the point where the preferred stock now yields 12%. What would be the new estimated value of Rolen’s preferred stock?

Kendra Enterprises has never paid a dividend. Free cash flow is projected to be $80,000 and $100,000 for the next 2 years, respectively; after the second year, FCF is expected to grow at a constant rate of 8%. The company’s weighted average cost of capital is 12%. a. What is the terminal, or horizon, value of operations? (Hint: Find the value of all free cash flows beyond Year 2 discounted back to Year 2.) b. Calculate the value of Kendra’s operations. Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Dozier’s weighted average cost of capital is WACC = 13%. a. What is Dozier’s terminal, or horizon, value? (Hint: Find the value of all free cash flows beyond Year 3 discounted back to Year 3.) b. What is the current value of operations for Dozier? c. Suppose Dozier has $10 million in marketable securities, $100 million in debt, and 10 million shares of stock. What is the intrinsic price per share? Reizenstein Technologies (RT) has just developed a solar panel capable of generating 200% more electricity than any solar panel currently on the market. As a result, RT is expected to experience a 15% annual growth rate for the next 5 years. By the end of 5 years, other firms will have developed comparable technology, and RT’s growth rate will slow to 5% per year indefinitely. Stockholders require a return of 12% on RT’s stock. The most recent annual dividend (D0), which was paid yesterday, was $1.75 per share. a. Calculate RT’s expected dividends for t = 1, t = 2, t = 3, t = 4, and t = 5. b. Calculate the estimated intrinsic value of the stock today, ^P0 . Proceed by finding the present value of the dividends expected at t = 1, t = 2, t = 3, t = 4, and t = 5 plus the present value of the stock price that should exist at t = 5, ^P5 . The ^P5 stock price can be found by using the constant growth equation. Note that to find ^P5 you use the dividend expected at t = 6, which is 5% greater than the t = 5 dividend. c. Calculate the expected dividend yield (D1/P0 ^ ), the capital gains yield expected during the first year, and the expected total return (dividend yield plus capital gains yield) during the first year. (Assume that P0 ^ = P0, and recognize that the capital gains yield is equal to the total return minus the dividend yield.) Also calculate these same three yields for t = 5 (e.g., D6/P5 Harris Company must set its investment and dividend policies for the coming year. It has three independent projects from which to choose, each of which requires a $3 million investment. These projects have different levels of risk and therefore different costs of capital. Their projected IRRs and costs of capital are as follows: Project A: Cost of capital = 17%; IRR = 20% Project B: Cost of capital = 13%; IRR = 10% Project C: Cost of capital = 7%; IRR = 9% Harris intends to maintain its 35% debt and 65% common equity capital structure, and its net income is expected to be $4,750,000. If Harris maintains its residual dividend policy (with all distributions in the form of dividends), what will its payout ratio be? Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion. This one-time unusual earnings growth won’t be maintained, though, and after 2014 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%. a. Calculate Boehm’s total dividends for 2014 under each of the following policies: (1) Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. (2) It continues the 2013 dividend payout ratio. (3) It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million investment is financed with debt). (4) It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy. b. Which of the preceding policies would you recommend? Restrict your choices to the ones listed, but justify your answer. c. Does a 2014 dividend of $9 million seem reasonable in view of your answers to parts a and b? If not, should the dividend be higher or lower? 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 a Biggerstaff & Biggerstaff (B&B), a privately held company owned by two brothers, each with 5 million shares of stock. B&B currently has free cash flow of $24 million, which is expected to grow at a constant rate of 5%. B&B’s financial statements report marketable securities of $100 million, debt of $200 million, and preferred stock of $50 million. B&B’s WACC is 11%. Answer the following questions.

a. Describe briefly the legal rights and privileges of common stockholders.

b. (1) Write out a formula that can be used to value any stock, regardless of its dividend pattern.

(2) What is a constant growth stock? How are constant growth stocks valued?

(3) What happens if a company has a constant g that exceeds its rs? Will many stocks

have expected g rs in the short run (i.e., for the next few years)? In the long run (i.e., forever)?

c. Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the yield on T bonds) is 7.0%, and that the market risk premium is 5%. What is the required rate of return on the firm’s stock?

d. Assume that Temp Force is a constant growth company whose last dividend (D0,

which was paid yesterday) was $2.00 and whose dividend is expected to grow indefinitely at a 6% rate.

(1) What is the firm’s current estimated intrinsic stock price?

(2) What is the stock’s expected value 1 year from now?

(3) What are the expected dividend yield, the expected capital gains yield, and the expected total return during the first year?

e. Suppose Temp Force’s stock price is selling for $30.29. Is the stock price based more on

long-term or short-term expectations? Answer this by finding the percentage of Temp

Force’s current stock price that is based on dividends expected during Years 1, 2, and 3.

f. Why are stock prices volatile? Using Temp Force as an example, what is the impact on the estimated stock price if g falls to 5% or rises to 7%? If rs changes to 12%% or to 14%?

g. Now assume that the stock is currently selling at $30.29. What is its expected rate of return?

Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return (assume the market is in equilibrium with the required return equal to the expected return)? A company currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price?

Crisp Cookware’s common stock is expected to pay a dividend of $3 a share at the end of this year (D1 = $3.00); its beta is 0.8; the risk-free rate is 5.2%; and the market risk premium is 6%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $40 a share. Assuming the market is in equilibrium, what does the market believe will be the stock’s price at the end of 3 years (i.e., what is P3 Assume that the average firm in your company’s industry is expected to grow at a constant rate of 6% and that its dividend yield is 7%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 = D0(1 + g) = D0(1.50)] this year and 25% the following year, after which growth should return to the 6% industry average. If the last dividend paid (D0) was $1, what is the estimated value per share of your firm’s stock? Simpkins Corporation does not pay any dividends because it is expanding rapidly and needs to retain all of its earnings. However, investors expect Simpkins to begin paying dividends, with the first dividend of $0.50 coming 3 years from today. The dividend should grow rapidly—at a rate of 80% per year—during Years 4 and 5. After Year 5, the company should grow at a constant rate of 7% per year. If the required return on the stock is 16%, what is the value of the stock today (assume the market is in equilibrium with the required return equal to the expected return)? Several years ago, Rolen Riders issued preferred stock with a stated annual dividend of

10% of its $100 par value. Preferred stock of this type currently yields 8%. Assume dividends are paid annually.

a. What is the estimated value of Rolen’s preferred stock?

b. Suppose interest rate levels have risen to the point where the preferred stock now yields 12%. What would be the new estimated value of Rolen’s preferred stock?

Kendra Enterprises has never paid a dividend. Free cash flow is projected to be $80,000 and $100,000 for the next 2 years, respectively; after the second year, FCF is expected to grow at a constant rate of 8%. The company’s weighted average cost of capital is 12%. a. What is the terminal, or horizon, value of operations? (Hint: Find the value of all free cash flows beyond Year 2 discounted back to Year 2.) b. Calculate the value of Kendra’s operations. Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Dozier’s weighted average cost of capital is WACC = 13%. a. What is Dozier’s terminal, or horizon, value? (Hint: Find the value of all free cash flows beyond Year 3 discounted back to Year 3.) b. What is the current value of operations for Dozier? c. Suppose Dozier has $10 million in marketable securities, $100 million in debt, and 10 million shares of stock. What is the intrinsic price per share? Reizenstein Technologies (RT) has just developed a solar panel capable of generating 200% more electricity than any solar panel currently on the market. As a result, RT is expected to experience a 15% annual growth rate for the next 5 years. By the end of 5 years, other firms will have developed comparable technology, and RT’s growth rate will slow to 5% per year indefinitely. Stockholders require a return of 12% on RT’s stock. The most recent annual dividend (D0), which was paid yesterday, was $1.75 per share. a. Calculate RT’s expected dividends for t = 1, t = 2, t = 3, t = 4, and t = 5. b. Calculate the estimated intrinsic value of the stock today, ^P0 . Proceed by finding the present value of the dividends expected at t = 1, t = 2, t = 3, t = 4, and t = 5 plus the present value of the stock price that should exist at t = 5, ^P5 . The ^P5 stock price can be found by using the constant growth equation. Note that to find ^P5 you use the dividend expected at t = 6, which is 5% greater than the t = 5 dividend. c. Calculate the expected dividend yield (D1/P0 ^ ), the capital gains yield expected during the first year, and the expected total return (dividend yield plus capital gains yield) during the first year. (Assume that P0 ^ = P0, and recognize that the capital gains yield is equal to the total return minus the dividend yield.) Also calculate these same three yields for t = 5 (e.g., D6/P5 Harris Company must set its investment and dividend policies for the coming year. It has three independent projects from which to choose, each of which requires a $3 million investment. These projects have different levels of risk and therefore different costs of capital. Their projected IRRs and costs of capital are as follows: Project A: Cost of capital = 17%; IRR = 20% Project B: Cost of capital = 13%; IRR = 10% Project C: Cost of capital = 7%; IRR = 9% Harris intends to maintain its 35% debt and 65% common equity capital structure, and its net income is expected to be $4,750,000. If Harris maintains its residual dividend policy (with all distributions in the form of dividends), what will its payout ratio be? Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion. This one-time unusual earnings growth won’t be maintained, though, and after 2014 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%. a. Calculate Boehm’s total dividends for 2014 under each of the following policies: (1) Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. (2) It continues the 2013 dividend payout ratio. (3) It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million investment is financed with debt). (4) It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy. b. Which of the preceding policies would you recommend? Restrict your choices to the ones listed, but justify your answer. c. Does a 2014 dividend of $9 million seem reasonable in view of your answers to parts a and b? If not, should the dividend be higher or lower? 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 a Biggerstaff & Biggerstaff (B&B), a privately held company owned by two brothers, each with 5 million shares of stock. B&B currently has free cash flow of $24 million, which is expected to grow at a constant rate of 5%. B&B’s financial statements report marketable securities of $100 million, debt of $200 million, and preferred stock of $50 million. B&B’s WACC is 11%. Answer the following questions.

a. Describe briefly the legal rights and privileges of common stockholders.

b. (1) Write out a formula that can be used to value any stock, regardless of its dividend pattern.

(2) What is a constant growth stock? How are constant growth stocks valued?

(3) What happens if a company has a constant g that exceeds its rs? Will many stocks

have expected g rs in the short run (i.e., for the next few years)? In the long run (i.e., forever)?

c. Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the yield on T bonds) is 7.0%, and that the market risk premium is 5%. What is the required rate of return on the firm’s stock?

d. Assume that Temp Force is a constant growth company whose last dividend (D0,

which was paid yesterday) was $2.00 and whose dividend is expected to grow indefinitely at a 6% rate.

(1) What is the firm’s current estimated intrinsic stock price?

(2) What is the stock’s expected value 1 year from now?

(3) What are the expected dividend yield, the expected capital gains yield, and the expected total return during the first year?

e. Suppose Temp Force’s stock price is selling for $30.29. Is the stock price based more on

long-term or short-term expectations? Answer this by finding the percentage of Temp

Force’s current stock price that is based on dividends expected during Years 1, 2, and 3.

f. Why are stock prices volatile? Using Temp Force as an example, what is the impact on the estimated stock price if g falls to 5% or rises to 7%? If rs changes to 12%% or to 14%?

g. Now assume that the stock is currently selling at $30.29. What is its expected rate of return?

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