1. Managerial Finance Session 4c
Nicole Hruban

2. Stock Valuation
You are considering three investments. The first is a bond that is selling in the market at $1,200. The bond has a $1,000 par value, pays interest at 14 percent, and is scheduled to mature in 12 years. For the bonds of this risk class you believe that a 12 percent rate of return should be required. The second investment that you are analyzing is a preferred stock ($100 par value) that sells for $80 and pays an annual dividend of $12. Your required rate of return for this stock is 14 percent. The last investment is a common stock ($35 par value) that recently paid a $3 dividend. The firm’s earnings per share have increased from $4 to $8 in 10 years, which also reflects the expected growth in dividends per share for the indefinite future. The stock is selling for $25, and you think a reasonable required rate of return for the stock is 20 percent.
a. Calculate the value of each security based on your required rate of return.
b. Which investment(s) should you accept? Why?
c. 1.If your required rates of return changed to 14 percent for the bond, 16 percent for the preferred stock, and 18 percent for the common stock, how would your answers change to parts (a) and (b)?
2.Assuming again that your required rate of return for the common stock is 20 percent, but the anticipated constant growth rate changes to 12 percent, would your answers to parts (a) and (b) be different?

3. Vb =
Stock Valuation +
Calculate the value of each security based on your required rate of return.
BOND:
Bond Value: $1,123.89

4. Stock Valuation +
Calculate the value of each security based on your required rate of return.
PREFERRED STOCK:
The dividend is a constant amount with no maturity date (i.e. infinite)
Preferred Stock Value: $85.71

5. Stock Valuation +
Calculate the value of each security based on your required rate of return.
COMMON STOCK:
Step 1: Calculate Compounding Growth Rate
$4 * (1+r)10 = $8
(1+r)10 = $2 /^1/10
1+r = $2^(1/10)
r= $2^(1/10) – 1 = ~ 7%

6. Stock Valuation +
Calculate the value of each security based on your required rate of return.
COMMON STOCK:
Step 2: Calculate Value of the common stock
𝑃𝑜= 3 (1+0.07) (0.2−0.07) = $24.69
Common Stock Value: $24.69

7. Stock Valuation
You are considering three investments. The first is a bond that is selling in the market at $1,200. The bond has a $1,000 par value, pays interest at 14 percent, and is scheduled to mature in 12 years. For the bonds of this risk class you believe that a 12 percent rate of return should be required. The second investment that you are analyzing is a preferred stock ($100 par value) that sells for $80 and pays an annual dividend of $12. Your required rate of return for this stock is 14 percent. The last investment is a common stock ($35 par value) that recently paid a $3 dividend. The firm’s earnings per share have increased from $4 to $8 in 10 years, which also reflects the expected growth in dividends per share for the indefinite future. The stock is selling for $25, and you think a reasonable required rate of return for the stock is 20 percent.
a. Calculate the value of each security based on your required rate of return.
b. Which investment(s) should you accept? Why?
c. 1.If your required rates of return changed to 14 percent for the bond, 16 percent for the preferred stock, and 18 percent for the common stock, how would your answers change to parts (a) and (b)?
2.Assuming again that your required rate of return for the common stock is 20 percent, but the anticipated constant growth rate changes to 12 percent, would your answers to parts (a) and (b) be different?

8. Stock Valuation b. Which investment(s) should you accept? Why?+
b. Which investment(s) should you accept? Why?
VALUE
SELLING PRICE
BOND
$1,123.89
$1,200
PREF. STOCK
$85.71
$80.00
COM. STOCK
$24.69
$25.00
You should buy the preferred stock. Because the market price of the investment is below the value it has to you!

9. Stock Valuation
You are considering three investments. The first is a bond that is selling in the market at $1,200. The bond has a $1,000 par value, pays interest at 14 percent, and is scheduled to mature in 12 years. For the bonds of this risk class you believe that a 12 percent rate of return should be required. The second investment that you are analyzing is a preferred stock ($100 par value) that sells for $80 and pays an annual dividend of $12. Your required rate of return for this stock is 14 percent. The last investment is a common stock ($35 par value) that recently paid a $3 dividend. The firm’s earnings per share have increased from $4 to $8 in 10 years, which also reflects the expected growth in dividends per share for the indefinite future. The stock is selling for $25, and you think a reasonable required rate of return for the stock is 20 percent.
a. Calculate the value of each security based on your required rate of return.
b. Which investment(s) should you accept? Why?
c. 1.If your required rates of return changed to 14 percent for the bond, 16 percent for the preferred stock, and 18 percent for the common stock, how would your answers change to parts (a) and (b)?
2.Assuming again that your required rate of return for the common stock is 20 percent, but the anticipated constant growth rate changes to 12 percent, would your answers to parts (a) and (b) be different?

10. Stock Valuation
1.If your required rates of return changed to 14 percent for the bond, 16 percent for the preferred stock, and 18 percent for the common stock, how would your answers change to parts (a) and (b)?
BOND:
Bond Value: $1,000
Preferred Stock:
Preferred Stock Value: $75
Common Stock:
Common Stock Value: $29.18

11. Stock Valuation +
c. Which investment would you chose with the changes rates?
VALUE
SELLING PRICE
BOND
$1,000
$1,200
PREF. STOCK
$75
$80.00
COM. STOCK
$29.18
$25.00
You would purchase the common stock, because it’s value is more than the selling price.

12. Stock Valuation
You are considering three investments. The first is a bond that is selling in the market at $1,200. The bond has a $1,000 par value, pays interest at 14 percent, and is scheduled to mature in 12 years. For the bonds of this risk class you believe that a 12 percent rate of return should be required. The second investment that you are analyzing is a preferred stock ($100 par value) that sells for $80 and pays an annual dividend of $12. Your required rate of return for this stock is 14 percent. The last investment is a common stock ($35 par value) that recently paid a $3 dividend. The firm’s earnings per share have increased from $4 to $8 in 10 years, which also reflects the expected growth in dividends per share for the indefinite future. The stock is selling for $25, and you think a reasonable required rate of return for the stock is 20 percent.
a. Calculate the value of each security based on your required rate of return.
b. Which investment(s) should you accept? Why?
c. 1.If your required rates of return changed to 14 percent for the bond, 16 percent for the preferred stock, and 18 percent for the common stock, how would your answers change to parts (a) and (b)?
2.Assuming again that your required rate of return for the common stock is 20 percent, but the anticipated constant growth rate changes to 12 percent, would your answers to parts (a) and (b) be different?

13. Stock Valuation
2.Assuming again that your required rate of return for the common stock is 20 percent, but the anticipated constant growth rate changes to 12 percent, would your answers to parts (a) and (b) be different?
You would want to now purchase the stock. Because of the expected increase in future dividends, the stock is now worth more to you ($42) than you would have to pay for it ($25) assuming that the selling price did not increase also.

14. Stock Valuation +
Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $4,25 per share and paid cash dividends of $2,55 per share (Do = $2.55). Grips earnings and dividends are expected to grow at 25% per year for the next 3 years, after which they are expected to grow at 10% to infinity. What is the maximum share price that Newman should pay for Grips if it has a required return of 15% on investments with risk characteristics similar to those of Grips?

15. Stock Valuation +
Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $4,25 per share and paid cash dividends of $2,55 per share (Do = $2.55). Grips earnings and dividends are expected to grow at 25% per year for the next 3 years, after which they are expected to grow at 10% to infinity. What is the maximum share price that Newman should pay for Grips if it has a required return of 15% on investments with risk characteristics similar to those of Grips?

16. Stock Valuation + + Po= 2.77 +3.01 + 3.27 + *
Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $4,25 per share and paid cash dividends of $2,55 per share (Do = $2.55). Grips earnings and dividends are expected to grow at 25% per year for the next 3 years, after which they are expected to grow at 10% to infinity. What is the maximum share price that Newman should pay for Grips if it has a required return of 15% on investments with risk characteristics similar to those of Grips? + +
Po= *
= = 81.09
Newman should not pay more than $81.09 per share

17. Stock Valuation +
You are evaluating the potential purchase of a small business currently generating $42,000 after tax cash flow (Do=$42,500). On the basis of a review of similar-risk investment opportunities, you must earn an 18% rate of return on the proposed purchase. Because you are relatively uncertain about the future cash flows, you decide to value using several possible assumptions about the growth rate of cash flows
What is the firm’s value if cash flows are expected to grow at an annual rate of 0% from now until infinity
What is the firm’s value if cash flows are expected to grow at a constant annual rate of 7% from now until infinity
What is the firm’s value if cash flows are expected to grow at an annual rate of 12% for the first 2 years, followed by a constant rate of 7% from year 3 to infinity

18. Stock Valuation +
What is the firm’s value if cash flows are expected to grow at an annual rate of 0% from now until infinity
D0 = $42,500
r = 18%
𝑃𝑜= 42, = $236,111.11
If 0% growth is assumed, the value is $236,111

19. Stock Valuation +
What is the firm’s value if cash flows are expected to grow at a constant annual rate of 7% from now until infinity
D0 = $42,500
r = 18%
g = 7%
𝑃𝑜= 42,500 (1+0.07) (0.18−0.07) = $413,409.09
If 7% growth is assumed (infinitely), the value is $413,409.09

20. Stock Valuation +
What is the firm’s value if cash flows are expected to grow at an annual rate of 12% for the first 2 years, followed by a constant rate of 7% from year 3 to infinity
𝑃𝑜= $42,500 ∗(1+0.12) $42,500 ∗ (1+0.12) 2 (1+0.18) 2 +
1 (1+0.18) 2 ∗ $42,500 ∗ ∗ −0.07 =
𝑃𝑜=40, , ∗ =
𝑃𝑜=40, , =$451,063.17
In this scenario the value is $451,063.17

21. Stock Valuation
You have the opportunity to buy the stock of CoolTech at its IPO. The stock is offered at $12.5 per share. You are wondering whether this is a fair price. To determine the value of the share you have decided to apply the free cash flow valuation model to the firm’s financial data.
Following are the key values:
Free Cash Flow
Year (t)
FCF
Other data
2013
700,000
Growth rate of FCF beyond 2016 to infinity 2%
2014
800,000
WACC = 8%
2015
950,000
MV Debt = $2,700,000
2016
1,100,000
MV Pref. Stock = $1,000,000
# shares outstanding = 1,100,000
Use the FCF to estimate CoolTech’s common stock value per share

22. Stock Valuation
You have the opportunity to buy the stock of CoolTech at its IPO. The stock is offered at $12.5 per share. You are wondering whether this is a fair price. To determine the value of the share you have decided to apply the free cash flow valuation model to the firm’s financial data.
Following are the key values:
𝑃𝑜= 700, ,000 (1+0.08) ,000 (1+0.08) ,100,000 (1+0.08) 4 +
1 (1+0.08) 4 ∗ $1,100,000 ∗ −0.02 =
𝑃𝑜=648, , , , *18,700,000 =
Po = 16,641,192

23. Stock Valuation
You have the opportunity to buy the stock of CoolTech at its IPO. The stock is offered at $12.5 per share. You are wondering whether this is a fair price. To determine the value of the share you have decided to apply the free cash flow valuation model to the firm’s financial data.
Following are the key values:
𝑃𝑜=648, , , , *18,700,000 =
Po = 16,641,192
MVE=Market Value of Operating Assets +Cash –Market Value of Debt – Market Value of Preferred Shares
MVE = 16,641, – 2,700,000 – 1,000,000
MVE = 12,841,192.68
Per share value = 12,841, / # shares outstanding =
Per share value = 12,841, / 1,100,000 = 11.67
Would you buy the stock ???