Test 1 Flashcards
Chapter 10
MJ company forecasts to pay a $5.00 dividend next year, which represents 100% of its earnings. This will provide investors with a 12% expected return. What if instead, MJ Company decides to plow back 40% of the earnings at the firm’s current return on equity of 20%. Calculate the value of the stock before and after the plowback decision. (with and without growth)
D1 = 5.00 Ke = 0.12 ROE = 0.20 Plowback = 0.40 --> Div 60%
g = ROE x Plowback
= 0.20 x 0.40
= 8%
Without growth
P = Div / (Ke - g)
= 5 / (0.12 - 0)
= 41.67
With growth Div = 5 x 60% = 3 P = Div / (Ke - g) = 3 / (0.12 - 0.08) = 3 / 0.04 = 75
Ch
You get paid 300,000 every year for 20 years and 500,000 for 20 years after that. With a rate of 6% what would be the PV of the total amount?
n= 20 i= 6% using Appendix D PVa = 300,000 (11.470) = 3,441,000 PVa = 500,000 (11.470) = 5,735,000 using Appendix B PV = 5,735,000 (0.312) = 1,789,320
3,441,000 + 1,789,320 = 5,230,320
The company paid a dividend of $1.67 last year. Dividends are expected to grow at 20% over the supernormal growth period of 3 years. They will then grow at a normal constant rate (g)of 5%. The required rate of return (Ke) is 9%. Calculate the price of the stock.
D1 = 1.67 supernormal g = 0.20 (3 years) g= 0.05 Ke = 0.09 i = 9% D1 = 1.67 x 1.20 = 2.00 2.00 (0.917) = 1.83 D2 = 2.00 x 1.20 = 2.40 2.40(0.842) = 2.02 D3 = 2.40 x 1.20 = 2.88 2.88(0.772)= 2.22 1.83 + 2.02 + 2.22 = 6.07 D4 = 2.88 x 1.05 = 3.02
P = Div / (Ke - g)
= 3.02 / (0.09 - 0.05)
= 3.02 / 0.04
= 75.50
P = 75.50 (0.772)
= 58.59
P = 58.69 + 6.07
= 64.36
Fastco Inc. Expects a EPS of 2.50. The company has an ROE of 13% and plows back 60% of its earnings. If the required return is 12%, calculate the value of the shares using the appropriate dividend discount model
EPS = 2.50 ROE = 0.13 Plowback = 0.60 --> 0.40 Div Ke = 0.12
g = ROE x Plowback
= 0.13 x 0.60
= 0.078
Div = 2.50 x 0.40
= 1
P = Div / (Ke- g)
= 1 / (0.12- 0.078)
= 1 / 0.042
= 23.81
Dividends are paid out at $1.20 per share, with a required rate of return bieng 10%. Estimated 15% growth rate for the next three years, after that a normal growth rate of 6% is expected
Div = 1.20
Ke = 0.10
supernormal g = 0.15 (3 years)
g = 0.06
D1 = 1.20 x 1.15 = 1.38 1.38(0.909) = 1.25 D2= 1.38 x 1.15 = 1.59 1.59(0.826) = 1.31 D3 = 1.59 x 1.15 =1.83 1.83(0.751) = 1.37 1.25 +1.31 +1.37= 3.93 D4 = 1.83 x 1.06= 1.94
P = Div /(Ke - g) = 1.94 / (0.10- 0.06) = 1.94 / 0.04 = 48.50 P = 48.50 (0.751) = 36.42 P= 36.42 + 3.93 = 40.35
What is annuity due?
payment that is made at the beginning of period
What is deferred annuity?
A annuity (payment) that its payment is due at a later time period
What is a perpetuity?
A bond or security with no fixed maturity date
What is the difference between single amount and annuity due?
Single amount is a single one time payment of a sum where as annuity due is a equal payment that is made every year for a certain number of years
What is a security?
Financial Instruments that enable funds to move from suppliers to demanders through the financial system ex. stocks, bonds, shares
What is the difference between Primary Markets vs. Secondary Markets?
Primary Markets have brand new securities that are being sold by a business and the profits go to them (the issuer) directly, where Secondary Markets are circulated securities and funds go to the seller (security issuer)
What is the difference between Money Market and Capital Market?
Money Market are securities with maturities of one year or less (Ex. T-Bills (main one), Commercial paper, Asset backed securities) where Capital Markets have long-term securities (Bonds, Stocks, Common and Preferred Shares)
Governments are also demanders in financial markets along with corporations. How do they raise money? What are some Government Securities?
By issuing debt securities aka Bonds
What are some Corporate Securities?
Preferred Stock, Common Stock, Bonds
What is Internal Funding vs. External Funding?
Internal Funding is when a company in turn plowsback their profits and reinvests it into their company as a form of raising money and external funding is when a company raises money by issuing financial securities
What is a coupon?
The interest paid to bondholders
What is par value?
the payment at the maturity
What is another name for unsecured bond holders?
Debentures
What is the order of priority of payment if a company is to “go under”
Senior/ Junior Secured debt holders, Senior and Subordinated Debentures, Preferred Stock, Common Stock
What is a covenant?
promises made by a firm in the bond indenture
Assume that Beta Corp borrows by issuing bonds that will mature in 15 years. The bonds have a coupon rate of 10%, paid annually. The 10% coupon rate is equal to the rate of return that investors expect to earn on a bond with this level of risk and time to maturity. (Assume bond is always $1000)
n = 15 years
i = 10%
Coupon rate = 1000 x 0.10
= 100
So payments of $100 are every year for 15 years and there is a 1000 par value at the end of the 15 years.
PVa = 100 (7.606)
= 760.60
PV = 1000 (0.239)
= 239
Bond price = 760.60 + 239
= 999.60
= 1000 (rounded)
0 1 2 3 15
I-----I----I-----I-------------I
100 100 100 100+1000HRK Industries Ltd. needs to raise $10 million in order to purchase new equipment. The company plans to issue 5 year bonds with a face value of $1,000 and a coupon rate of 6.3% (semi- annual payments). What is the price of the bond?
n = 5 years x 2 (semi annually = 10 i = 6.3%/ 2 (semi annually) = 0.0315 1000 x 0.0315 = 31.50 Therefore, there is payments of 31.50 being paid every period on top of a value of 1000 after the 5 years PVa = A(1-(1 + i)^-n)/ i) = 31.50 (1 - (1+ 0.0315) ^-10/ 0.0315) = 31.50 (8.4652733878) =266.66
PV = FV (1+ i )^-n
= 1000 (1+ 0.0315)^-10
= 1000 (0.7333438883)
= 733.34
Bond Price = 266.66 + 733.34
= 1000
What is a Share price?
The market value of the shares of a company determined by buyers and seller s in the market place
What is EPS?
The net earnings of a company dividend by the number of outstanding shares
