Suppose a firm pays a dividend on it\'s stock at the end of every period, the st

Question

Suppose a firm pays a dividend on it's stock at the end of every period, the stock's beta is 1.2, the expected dividend next period is $2.2, and dividends are expected to grow two percent every period forever. If the expected return on the market is 11.2-percent and the risk free rate is 3.3-percent, what is the most you should pay for the stock based on the CAPM and constant growth stock valuation model.

2 Suppose a firm’s free cash flows are expected to be $27,680 at the end of the current period and are expected to grow three percent each period thereafter. If the cost of capital is 11.6-percent per period and the market value of debt is $130,293, calculate the fair market value of a single share of stock if there are 8,000 shares outstanding.

Question 3 Suppose a firm’s free cash flows are expected to be $26,900 at the end of the current period and are expected to grow three percent each period thereafter. If the cost of capital is 10.4-percent per period and the market value of debt is $124,894, calculate the fair market value of the equity capital i.e. market capitalization.

Question 4 Suppose a common stock pays dividends at the end of each period and the stock has just paid a dividend in the amount of $3.2. If the stock's dividend growth rate is 20-percent for the next two periods and then 3.2-percent per period for every period thereafter and the discount rate is 10.3-percent per period, what is the most you should pay for the stock according to the constant growth stock valuation model.

Question 5 Suppose a common stock pays dividends at the end of each period and the stock has just paid a dividend in the amount of $3.3. If the stock's dividend growth rate is 25-percent for the next two periods and then 3.5-percent per period for every period thereafter and the discount rate is 12.2-percent per period, what is the most you should pay for the stock according to the constant growth stock valuation model.

Explanation / Answer

Question 1:

We need to compute the Ke using CAPm model = Rf + beta (RM- Rf)

Rf = risk free rate

RM = market rate

Beta = stock risk

= 3.3 + 1.2(11.2- 3.3)

= 12.78% is Ke

To compute the price of the stock = Dividend * growth /( Ke - g)

= 2.2/(0.1278-.02)

=$20.40 is the price of the stock

Question 2:

To compute the value of share price using free cash flow method

= FCFF1/( cost of capital - growth rate)

= 27680 /(.116-.03)

value of firm = 321860

Value of equity = 321860 - 130293 = 191567

hence the value of share = 191567/8000 shares = $23.95 is the price of the share

question 3)

To compute the market value of equity :

= FCFF1/( cost of capital - growth rate)

= 26900 /(.104-.03)

value of firm = 363513

Value of equity = 363513 - 124894 = 238619

Hence the market value of equity = 238619

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