Chap004
CHAPTER 4
The Value of Common Stocks
Answers to Problem Sets
1. a. True
b. True
2. Investors who buy stocks may get their return from capital gains as well as dividends. But the future stock price always depends on subsequent dividends. There is no inconsistency.
3. P0 = (5 + 110)/1.08 = $106.48
4. r = 5/40 = .125.
5. P0 = 10/(.08 - .05) = $333.33.
6. By year 5, earnings will grow to $18.23 per share. Forecasted price per share at year 4 is 18.23/.08 = $227.91.
7. 15/.08 + PVGO = 333.33; therefore PVGO = $145.83.
8. Z’s forecasted dividends and prices grow as follows:
Calculate the expected rates of return:
From year 0 to 1:
From year 1 to 2:
From year 2 to 3:
Double expects 8% in each of the first 2 years. Triple expects 8% in each of the first 3 years.
9. a. False
b. True.
10. PVGO = 0, and EPS1 equals the average future earnings the firm could generate under no-growth policy.
11. Free cash flow is the amount of cash thrown off by a business after all investments necessary for growth. In our simple examples, free cash flow equals operating cash flow minus capital expenditure. Free cash flow can be negative if investments are large.
12. The value at the end of a forecast period. Horizon value can be estimated using the constant-growth DCF formula or by using price–earnings or market– book ratios for similar companies.
13. If PVGO = 0 at the horizon date H, horizon value = earnings forecasted for H + 1 divided by r.
14. Newspaper exercise, answers will vary
15.
Expected Future Values
Present Values
Horizon Period (H)
Dividend (DIVt )
Price
(Pt )
Cumulative Dividends
Future Price
Total
0
100.00
100.00
100.00
1
10.00
105.00
8.70
91.30
100.00
2
10.50
110.25
16.64
83.36
100.00
3
11.03
115.76
23.88
76.12
100.00
4
11.58
121.55
30.50
69.50
100.00
10
15.51
162.89
The Value of Common Stocks
Answers to Problem Sets
1. a. True
b. True
2. Investors who buy stocks may get their return from capital gains as well as dividends. But the future stock price always depends on subsequent dividends. There is no inconsistency.
3. P0 = (5 + 110)/1.08 = $106.48
4. r = 5/40 = .125.
5. P0 = 10/(.08 - .05) = $333.33.
6. By year 5, earnings will grow to $18.23 per share. Forecasted price per share at year 4 is 18.23/.08 = $227.91.
7. 15/.08 + PVGO = 333.33; therefore PVGO = $145.83.
8. Z’s forecasted dividends and prices grow as follows:
Calculate the expected rates of return:
From year 0 to 1:
From year 1 to 2:
From year 2 to 3:
Double expects 8% in each of the first 2 years. Triple expects 8% in each of the first 3 years.
9. a. False
b. True.
10. PVGO = 0, and EPS1 equals the average future earnings the firm could generate under no-growth policy.
11. Free cash flow is the amount of cash thrown off by a business after all investments necessary for growth. In our simple examples, free cash flow equals operating cash flow minus capital expenditure. Free cash flow can be negative if investments are large.
12. The value at the end of a forecast period. Horizon value can be estimated using the constant-growth DCF formula or by using price–earnings or market– book ratios for similar companies.
13. If PVGO = 0 at the horizon date H, horizon value = earnings forecasted for H + 1 divided by r.
14. Newspaper exercise, answers will vary
15.
Expected Future Values
Present Values
Horizon Period (H)
Dividend (DIVt )
Price
(Pt )
Cumulative Dividends
Future Price
Total
0
100.00
100.00
100.00
1
10.00
105.00
8.70
91.30
100.00
2
10.50
110.25
16.64
83.36
100.00
3
11.03
115.76
23.88
76.12
100.00
4
11.58
121.55
30.50
69.50
100.00
10
15.51
162.89