Equity (share) valuation (Ch 7)

Question 1

7-1: determining the market price of Preferred Shares

Determine the market price of a $50 par value preferred share that pays annual dividends based on a 7% dividend rate when market rates are

a. 7%
b. 8%
c. 6%

Answer 1

Pps = Dp / Kp

A)Dp = 50 x 0.07 = $3.50

3. 50 / .07 = $50
   b)
4. 50 / .08 = 43.75
   c) 3.50 / 0.06 = 58.33

Question 2

7-2: Estimating the required rate of return on preferred shares

Determine the required rate of return on preferred shares that provide a $6 annual dividend if they are selling for $70.

Answer 2

Kp = Dp / Pps

6 / 70 = 8.57%

Question 3

7-3: estimating the price of a common share for a one year holding period

An investor buys a common share and estimates she will receive an annual dividend of $0.50 per share in one year. She estimates she will be able to sell the share for $10.50. Estimate its value, assuming the investor requires a 10% return on this investment.

Answer 3

Po= (Dn + Pn) / (1 to Kc) exponent n

(.05 + 10.5) / (1 +0.10) exponent 1
= $10.00

Question 4

7-4: Using the constant Growth DDM

Assume a company is currently paying $1.10 per share in dividends. Investors expect dividends to grow at an annual rate of 4% indefinitely, and they require a 10% return on the shares. Determine the price of these shares.

Answer 4

P0 = D1 / (KC -g)

D1 = (1.10) (1 + 0.04) = $1.144

1.144 / (0.1 - 0.04) = $19.07

Question 5

7-5: Estimating the required rate of return Using the DDM

The market price of a company’s share is $12 each; the estimated dividend at the end of this year (d1) is $0.60; and the estimated long-term growth rate in dividends (g) is 4%. Estimate the implied required rate of return on these shares

Answer 5

(Dividend y 1 / Price ) + growth rate

(0.60 / 12) + 0.04

=0.05 + 0.04
= 0.09
= 9%

Question 6

7-6: Estimating PVGO

A company’s shares are selling at $20 each in the market. The company’s EPS is expected to be $1.50 next year, and the required return on the shares is estimated to be 10%. Estimate the PVGO per share

Answer 6

PVGO = P0 - ( EPS / KC)

= 20 - (1.50 / 0.1)
= 20 - 15
= $5.00

Question 7

7-7: More pessimistic inputs of the constant growth DDM

Revisit the company in example 7-4 that is currently paying $1.10 per share in dividends. This time, revise the expectations for annual growth in dividends to 3% (from 4%) and revise the estimated required rate of return to 11% (from 10%). re -estimate the price of these shares

Answer 7

Po = (d1 / (Kc -g)

D1= (1.10) (1 + 0.03) = 1.133

1.113 / (0.11 -0.03)
= $14.16

Question 8

7-7: More pessimistic inputs of the constant growth DDM

Revisit the company in example 7-4 that is currently paying $1.10 per share in dividends. This time, revise the expectations for annual growth in dividends to 5% (from 4%) and revise the estimated required rate of return to 9% . Re-estimate the price of these shares

Answer 8

P0 = (d1 / (Kc - g)

D1 = (1.10) (1 + 10.05) = $1.155

1.155 / (0.09 -0.05) = $28.88