16. (3 points) An investor is considering buying stock in KSB Company. KSB is ex

Question

16. (3 points) An investor is considering buying stock in KSB Company. KSB is expected to pay a ycar-end dividend (DI) of SO.88 per share. The stock's Beta is 1.2. The Risk Free Rate is 4 4 %, and the Market Risk Premium is 8 %. Dividend Growth (G) is expected to be constant. The current stock pnce is $ 36.00 share. Assuming the Stock Market is in "equilibrium", what is KSB's estimated stock price in three (3) years? A. $12.03 B. $ 36,88 C. $41.04 D. $ 49.98 17. (3 points) The Lion's Corporation (TLC) is a manufacturer of "unpadded football helmets"&"dropped-ball receivers' mittens". Financial Analysts project Free Cash Flows (FCF's) during the next 3 years as illustrated below. After year 3, FCF's are expected to grow at 7 % per year (from concession stand sales)TLC's WACC = 14 % TLC has 10 million shares outstanding and $100 million debt on its Balance Sheet, what precpg share should an investor be willing to pay for TLC stock (except for the %'s, all #'s are in S million)? Time Period (end of year) 1 -15 FCF 10 35 A. $ 22.61 B. $ 27.93 C$37.93 D. $ 42.79 Formulas/Equations SML Equation: Required Rate of Return = Risk-Free Rate + (Market Premium) (Beta Coefficient) K(s)-(Di / Po) + G Di-(Do) (1 + G) G=Growth Rate Po=DI / (Ks-G) Pn=Po(1+G)" Terminal = ECF(n)ata RRR (k) k(RF) +(k-Market-k-RF) (Beta) = FCF (n + 1) Value WACC -G

Explanation / Answer

16

According to CAPM,

Expected return = risk free rate + beta*market risk premium

= 4.4% + 1.2*8% = 14%

According to dividend-discount model,

P0 = D1/(R-G)

P0 = Current stock price

D1 - Dividend at t =1

R - Required rate

G - Growth rate

36 = 0.88/(0.14-g)

g = 0.1156 = 11.56%

D1 = 0.88

D2 = 0.88*1.1156 = 0.98

D3 = 0.98*1.1156 = 1.10

D4 = 1.10*1.1156 = 1.22

P3 = D4/(R-g) = 1.22/(0.14-0.1156) = 49.98

Stock price in year 3 = $49.98

Option D.

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