Explain.

Homework 6 Stock Valuation
Mucho Manufacturing is a mature firm in the machine tool component industry. The firm’s most recent common stock dividend was $4.75 per share. Because of its maturity as well as its stable sales and earnings, the firm’s management feels that dividends will remain at the current level for the foreseeable future.
If the required return is 12%, what will be the value of Scotto’s common stock?
If the firm’s risk as perceived by market participants suddenly increase, causing the required return to rise to 21%, what will be the common stock value?
Judging on the basis of your findings in parts a and b, what impact does risk have on value? Explain.
White Drums, Inc., is a well-established supplier of fine percussion instruments to orchestras all over the United States. The company’s class A common stock has paid a dividend of $2.50 per share per year for the last 30 years. Management expects to continue to pay at that amount for the foreseeable future. Sally Talbot purchased 1,000 shares of Moon class A common 10 years ago at a time when the required rate of return for the stock was 12%. She wants to sell her share today. The current required rate of return for the stock is 16%. How much capital gain or loss will Sally have on her shares?
Use the constant-growth model (Gordon growth model) to find the value of each firm shown in the following table.
Firm
Growth
Required return
Divid Today
A
$9.00
4%
8%
B
$3.82
8%
12%
C
$1.65
10%
14%
D
$6.50
8%
11%
A7X Corp. just paid a dividend of $1.55 per share. The dividends are expected to grow at 2l percent for the next eight years and then level off to a growth rate of 3.5 percent indefinitely. If the required return is l2 percent, what is the price of the stock today?
Ignatius Industries is considering going public but is unsure of a fair offering price for the company. Before hiring an investment banker to assist in making the public offering, managers at Ignatius have decided to make their own estimate of the firm’s common stock value. The firm’s CFO has gathered data for performing the valuating using the free cash flow valuation model.
The firm’s weighted average cost of capital is 15%, and it has $2,500,000 of debt at market value and $950,000 of preferred stock at its assumed market value. The estimated free cash flows over the next 5 year, 2017 through 2021, are given below. Beyond 2021 to infinity, the firm expects its free cash flow to grow by 3% annually.
Year
FCF
2017
$250,000
2018
325,000
2019
810,000
2020
950,000
2021
1,690,000
Estimate the value of Ignatius Industries’ entire company by using the free cash flow valuation model.
Use your finding in part a, along with the data provided above, to find Ignatius Industries’ common stock value.
If the firm plans to issue 100,000 shares of common stock, what is its estimated value per share?
Eric Enterprises’ stock has a required return of 16.8%. The company, which plans to pay a dividend of $3.75 per share in the coming year, anticipates that its future dividends will increase at an annual rate consistent with that experienced over the 2015-2021 period, when the following dividends were paid:
Year
Div per Shr
2015
$2.00
2016
$2.45
2017
$2.55
2018
$2.80
2019
$3.25
2020
$3.40
2021
$3.50
If the risk-free rate is 4%, what is the risk premium on Eric’s stock?
Using the constant-growth model, estimate the value of Eric’s stock.
Explain what effect, if any, a decrease in the risk premium would have on the value of Eric’s stock.
Some videos you may find helpful.
Equity Valuation
Calculating the Dividend Growth Rate
Variable Growth Model

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