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Chapter 9 Questions

Chapter 9 Questions. Q1. What are 5 important features or characteristics of “Common Stock” as long term financial instrument? How is it different from a debt instrument like a “Bond”? -No maturity date -No legal right to receive dividends or have stock repurchased

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Chapter 9 Questions

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  1. Chapter 9 Questions Q1. What are 5 important features or characteristics of “Common Stock” as long term financial instrument? How is it different from a debt instrument like a “Bond”? -No maturity date -No legal right to receive dividends or have stock repurchased -Right to vote for board of directors -Uncertain/unknown/variable cash flow returns -Legally inferior to all other company obligations -Dividends not deductible expense for income tax purposes Q2. “Preferred Stock” is sometimes referred to as a “hybrid” security; what does this mean? How is “Preferred Stock” different from “Common Stock”? -”Hybrid” means it has some features similar to Debt and some features similar to Common Stock. -It is like Common Stock: No hard maturity date (but may have a hard “optional redemption date”; it offers a Dividend per share that the issuing Company is not legally obligated to pay. - It’s Dividend is usually a fixed, known amount, payable on fixed known future dates (like Debt interest rate and interest expense). Q3. Farmsdale National Bank issued a series of preferred stock four years ago which pays a fixed annual dividend of $3.75 per share and has no stated maturity date. An investor with a 6.50% required return expectation has just offered $52.50 per share for this preferred stock. Is this the final offer expected from this investor if the owner of the preferred stock refuses to sell? PPS = Dividend per share = $3.75 = $57.69 ; Investor believes it is Investors’ Required Return 0.065 worth $57.69 so he/she is willing to pay this much.

  2. Chapter 9 Questions Q4. Jory bought 950 shares of common stock issued by MacGregor Corporation and paid $43.75 per share on September 30, 2010. On September 30, 2011, Jory sold the 950 shares for $52.25 per share. On December 15, 2009, December 15, 2010 and December 15, 2011, the MacGregor Corporation paid a dividend of $1.50 per share in each of those years. What was Jory’s total return in percentage terms? Total Dollar Return = Total Dividends + Total Capital Gain(Loss) Total Dollar Return = [ 950 shares x $1.50 = $1,425.00] + [950 shares x ($52.25 less $43.75) = 950 x $8.50 = $8,075.00] Total Dollar Return = $1,425.00 + $8,075.00 = $9,500.00 Total Percentage Return = Total Dollar Return = $9,500 . Total Dollars Paid (950 shares x $43.75) Total Percentage Return = $9,500 . = 0.228571 = 22.8571% $41,562.50 Q5. NewCorp common stock paid a $3.60 per share dividend last year. Terry believes it is likely the dividend will grow at an average annual rate of 4.50% per year and believes the stock is worth $15.00 per share. What is Terry’s required return for this stock? KNewCorp = D1 + g= D1 = D0 x (1 + g) = $3.60 x (1+ 0.045) + 0.045 P0 P0 $15.00 KNewCorp = $3.762 + 0.045 = 0.2508 + 0.045 = 0.295800 = 29.58%   $15.00

  3. Q6. Jacksonville Machinery Company has 4,500,000 shares of common stock outstanding with a market price of $25.50 per share. The company also has $100 million of total debt outstanding. It’s annual Free Cash Flow is expected to be $10.50 million during the next 12 months, and the investment community believes annual Free Cash Flow will grow 6.00% per year for the foreseeable future. What required return do investors have for this company? VF = FCF1 VF = VD + VPS +VE = $100 mil. + ($25.50 x 4.5 mil.) ( WACC – g ) = $100 mil. + $114.75 mil. = $214.75 mil. WACC = FCF1.+ g = $10.5 . + 0.600 = 0.048894 + 0.0600 = 0.108894 = 10.89% VF $214.75 Q7. What is the estimated price per share an investor may have for the stock of a company which is expected to pay a dividend of $2.40 per share in the next 12 months and has the potential to grow its dividend by 8% per year if the investor has a total return requirement of 18.50%? P0 = D1. = $2.40 . = $2.40 . = $22.857143 = $22.86 ( R - g ) ( 0.1850 – 0.0800 ) (0.1050) Chapter 9 Questions

  4. Chapter 9 Questions Q8. A company expects its ability to pay dividends will grow 8% for next year, 9% the year after that, 10% the year after that, and then in the fourth year grow at an average rate of at least 5% per year forever. The company paid a $1.50 dividend last year, and investors expect to earn a total return of 30% for this stock. What is the expected price of this stock today? (Round to 4 decimal places in your calculations). D0 = $1.5000 D1 = $1.5000 x (1.08) = $1.6200 D2 = $1.6200 x (1.09) = $1.7658 D3 = $1.7658 x (1.10) = $1.9424 D4 = $1.9424 x (1.05) = $2.0395 P3 = D4. = $2.0395 = $8.1580 N = 3 I = 30 FV = $8.1580 comp.PV = $3.7132 (0.30 – 0.05) ( 0.25 ) NPV of dividends for Year 1 thru Year 3: I = 30 CF0 = 0 CF1 = $1.6200 CF2 = $1.7658     CF3 = $1.9424; NPV = $3.1751 P0 = $3.7132 + $3.1751 = $6.8883

  5. Chapter 9 Questions Q9. Annual Free Cash Flow for XYZ Corp. is expected to reach $12 million in the next 12 months, and is expected to grow at an annual rate of 7% per year. Management believes the minimum acceptable annual return on assets (based on their weighted average cost of capital) is 16%. The company has $65 million in debt (market value) on its balance sheet which was raised a few years ago. What is the estimated enterprise value for the company, and then the value of all shares of stock collectively, for this company, respectively? Round to two decimal places. VF = FCF1 VF = $12 mil. = $133.33 mil ( WACC – g ) ( 0.1600 – 0.0700 ) VE = VF - VD - VPS = $133.33 mill less $65 mil. less $0 = $68.33 mil.

  6. Chapter 9 Questions Q10. A company had annual Free Cash Flow last year of $4.9 million and has been experiencing difficulties growing as its industry is undergoing rapid consolidation. Its largest shareholder has an annual required rate of return of 15% for the stock and believes growth could average 8% for the foreseeable future if the company can reduce its fixed costs. If there are 2.5 million shares outstanding and the company has $6 million of debt, what might the largest shareholder believe about the current price per share? VF = FCF1 VF = $4.9 mil. x (1 + 0.08) = $5.292 mil. = $75.60 mil. ( WACC – g ) ( 0.1500 – 0.0800 ) (0.0700) VE = VF - VD - VPS = $75.6 mill less $6 mil. less $0 = $69.6 mil. P0 = VE.= $69.6 mil. . = $27.84 per share   ( No. of Common Shares) 2.5 mil. shares Q11. MNO Corp. is expected to pay a dividend this year of $4.80 per share. It’s stock price today is $80.00 per share. If investors current annual required return for this stock is 13%, what average growth rate for future dividends are investors expecting for this stock? RMNO = D1 + g g = RMNO – D1 = 13.00% - $4.80   = 0.1300 – 0.0600 P0 P0 $80.00 g = 13.00% less 6.00% = 7.00%

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