Financial Management

7-2 - Boehm Incorporated is expected to pay a $1.50 per share dividend at the end of this year (i.e., D1 = $1.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs, is 15%. What is the value per share of Boehm’s stock?

D1= $1.50 per share

g = 7%

rs= 15%

Therefore the value of a share of Boehm Stock is:

P^0 = D1 /(rs – g)

P^0 = 1.50/(0.15-0.07)

P^0 = $18.75

7-4 PREFERRED STOCK VALUATION

7-4 - 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?

Dividend = $5

Preferred = $50

Therefore the stock’s required rate of return is:

^P 0 = D/rs

rs = D/^P 0

rs = 5/50

rs = 0.10 or 10%

7-5 NON-CONSTANT GROWTH VALUATION

7-5 - 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, 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?

D0 = $2.00

g = 20% for 2 years

g = 7% there after

Bi = 1.2

Rf = 7.5%

RPm = 4%

Rs = Rf +(bi* RPm)

Rs = 7.5 +(1.2*4)

Rs = 12.3

Therefore the estimate of the stock’s current price will be:

D0 $2.00

g0 to 1 20.0%

g1 to 2 20.0%

gn 7.0%

rs 12.3%

Year

1 2

D1 D2

Expected dividends $2.40 $2.88

Expected P2 $58.14

PV of expected dividends $4.42

PV of expected P2 $46.10

Expected P0 $50.53

9-2 AFTER-TAX COST OF DEBT

9-2 - LL Incorporated’s currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL’s after-tax cost of debt?

After-tax component cost of debt = rd(1 − T)...