# Fin 571 Week 3 Problem Set

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Alisha Joseph

May 18, 2011

FIN/571

Trina Hall

A14. (Stock valuation) Suppose Toyota has non maturing (perpetual) preferred stock outstanding

that pays a \$1.00 quarterly dividend and has a required return of 12% APR (3% per quarter).

What is the stock worth?

PV perpetuity = Div/R = \$1.00/.03 = \$33.33

B20. (Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its

common stock. James Weber, an analyst for A. G. Edwards, believes that Medtrans will

begin paying a \$1.00 per share dividend in two years and that the dividend will increase

6% annually thereafter. Bret Kimes, one of James’ colleagues at the same firm, is less optimistic.

Bret thinks that Medtrans will begin paying a dividend in four years, that the dividend

will be \$1.00, and that it will grow at 4% annually. James and Bret agree that the

required return for Medtrans is 13%.

a. What value would James estimate for this firm?

b. What value would Bret assign to the Medtrans stock?

a. Pt = Dt + 1 / r-g i = 13% \$1 in year 2 growing at 6%

a1. P1 = D2 / r-g a2. 14.29 x .885 (from table) = 12.64

P1 = 1/.13 - .06 or

P1 = 14.29 14.29/ (1.13)1=\$12.64 is the value

b. \$1 in 4 years at 4% i = 13%

b1. P3 = D4 / r-g b2. 11.11 x .693 (from table) = 7.70 value

P3 = 1 / .13 - .04 or

P3 = 11.11 14.29 / (1.13)3 = 11.11/1.44 = 7.70

C1. (Beta and required return) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.

a. Calculate the expected returns on the stock market and on Chicago Gear stock.

b. What is Chicago Gear’s beta?

c. What is Chicago Gear’s required return according to the CAPM?

A1. ERM = (.2 x -.10) + (.35 x .10) + (.30 x .15) + (.15 x .25) = .0975 = 9.75%

A2. ERM = (.2 x -.15) + (.35 x .15) + (.30 x .25) + (.15 x .35) = .15 = 15%

B) om2= .20(-0.10-.0.0975)2 + 0.35(0.10-0.0975)2

+...