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8 -- Part 4: Stock Valuation

- The free cash flow to equity approach is one of the P8.18 approaches.
- The free cash flow to equity model projects the free cash flows that a firm will generate over time, discounts them to the present, and divides by the number of shares outstanding to estimate a common stock's intrinsic value.

- The price-to-earnings approach uses projected earnings and the stock's P/E ratio to determine whether a stock is fairly valued.

- The chapter looked at several widely used procedures for stock valuation.
- One approach definitely does not fit all situations in stock evaluation.
- The P/E and P/CF approaches are more suited to growth oriented firms.
- Other price- relative procedures can be used to value companies that have little or nothing in earnings.

- MyFinanceLab will give you further practice, as well as videos, animations, and guided solutions.

- Finance would be of interest to you.
- To calculate the maximum price you'd be willing to pay for this stock, use the historical and forecasted data reported in the source you select, along with one of the valuation techniques described in this chapter.

- An investor might use the constant-growth DVM to value a stock.
- There are a number of situations that could affect the computed value of a stock.
- Look at each one individually and see if it will cause the computed value of a stock to go up, go down, or stay the same.
- Explain your answers.

- The dividendPayout ratio goes up.

- The equity multiplier is going down.

- T-bill rates go down.

- The net profit margin goes up.

- The total asset turnover has fallen.

- All other variables in the model are the same.

- According to an investor in Amman, Jordan, next year's sales for Amman Intercontinental Hotels, Inc. would be about 150 million Jordanian dinar.
- The company has 10 million shares outstanding, a net profit margin of 15%, and aPayout ratio of 40%.

- Next year's figures are expected to hold.
- The company had $35 million in sales in 2016 and is expected to have $5 million in sales this year.
- The company's net profit margin increased to 4% in 2016 and is expected to increase to 6 by the end of the year.
- Estimate the company's net profit.

- HighTeck has an ROE of 15%.
- Its dividends per share are $0.20, and its earnings per share are $2.00.

- Black Hole Company paid $90 million of interest expense last year, and the average rate of interest was 15%.
- The company pays no dividends.
- Estimate next year's interest expense if interest rates fall by 20% and the company keeps a constant equity multiplier of 25%.

- The company's historical dividend growth rate can be found in an excel spreadsheet.

- Popp is considering buying some shares of R. H. Lawncare Equipment.
- She thinks the price of the stock will go up to $60 over the next three years.
- She expects to receive annual dividends of $4 per share during that time.

- According to investors, Amalgamated Aircraft Parts, Inc. will pay a dividend of $2.50 in the coming year.
- The rate of return on the company's shares needs to be 12% for investors to be happy.
- The intrinsic value of the company's common shares can be found using the dividend valuation model.

- Danny is thinking about buying stock.
- The stock has a constant annual dividend of $2.00 per share and is currently trading at $20.
- Danny requires a 12% rate of return for this stock.

- Larry and Curley are related.
- They're both serious investors, but they don't agree on how to value stocks.
- Larry likes to use the valuation model.

- Right now, both of them are looking at the same stock, American Home Care Products, Inc.
- The company has been listed on the New York Stock Exchange for over 50 years and is considered to be a mature, rock-solid, dividend-paying stock.

- The company's latest dividends of $4 a share are expected to grow to $4.32 next year, to $4.67 the year after that, and to $5.06 in three years.
- You think dividends will grow at a constant rate after that.

- The variable growth version of the dividend valuation model can be used to find the value of the stock.

- If you plan to hold the stock for three years, you should be able to sell it immediately after the $5.06 dividend is paid.
- Assume a required return of 15%.

- Imagine buying the stock today and paying the same price as you calculated.
- You receive dividends when you hold the stock for three years.
- The expected return on the stock is calculated using the IRR approach.

- The stock's current market price is $44.65.

- A friend of yours agrees with your projections of Bufford's future dividends, but he believes that in three years, the stock will be selling in the market for $53.42.

- Let's assume you're thinking about buying stock in West Coast Electronics.
- You have discovered that the stock pays annual dividends of $5.00 a share indefinitely.
- It trades at a P/E of 10 times earnings.
- You will use a risk-free rate of 3% in the CAPM along with a market return of 10%.
- You would like to hold the stock for three years, at the end of which you think the price will be $7 a share.
- The IRR approach can be used to find the security's expected return.
- To put a price on this stock, use the dividend valuation model.

- The price of a share of the company has gone up.
- The company does not pay dividends.
- The price is expected to be QR30 per share three years from now.

- Shoreline Light and Gas paid its stockholders an annual dividend of $3 a share.
- The company's annual dividends would grow at a rate of 10% per year for the next five years and then grow at a rate of 6 percent thereafter, according to a report by a major brokerage firm.

- To find the price you should be willing to pay for this stock, use the variable-growth DVM and required rate of return.

- The stock's intrinsic value can be found using all the other informa tion.

- Comment on your findings if you contrast your two answers.

- Three companies in the past year paid the same annual dividend of $2.25 a share.

- The appropriate DVM is used to value these companies.

- New Millennium Company had net income of $2.5 million last year.
- New investments in working capital and fixed assets of $100,000 and $350,000 were made.

- The company's free cash flow is expected to grow at 5% per year.

- There are 3.5 million shares of common stock outstanding.

- The company's P/E ratio is based on next year's earnings, assuming they grow at the same rate as free cash flow.

- A company with sales of $250 million is expected to grow by 20% next year.
- The growth rate in sales is expected to be 10% for the year after next.
- The company is expected to have a net profit margin of 8% and aPayout ratio of 50% over the next two years.
- The stock trades at a P/E of 15 times earnings, and the investor needs to return 20%.

- The stock is trading at 15 per share, so use the IRR approach to determine the expected return.

- You can find the holding period returns for this stock.

- A major investment service has just given Oasis Electronics its highest investment rating, along with a strong buy recommendation.
- You decided to look for yourself and place a value on the company's stock.
- This year Oasis paid its stockholders an annual dividend of $3 a share, but because of its high rate of growth in earnings, its dividends are expected to grow at the rate of 12% a year for the next four years and then to level out at 9% a year The stock has a riskfree rate of return of 5% and an expected return on the market of 11%.
- Put a value on this stock by using the CAPM to find the required rate of return.

- Consolidated Software is expected to start paying dividends in four years.
- Consolidated will not pay dividends for three more years and then will pay its first dividend of $3 per share in the fourth year.
- The company is expected to continue paying dividends once they start.

- To place a value on this company's stock, use the constant-growth DVM.

- You want to use the P/E approach to value the shares if you buy some stock in Affiliated Computer Corporation.
- Next year's earnings are expected to come in at about $4.00 a share.
- Although the stock trades at a relative P/E of 1.15 times the market, you believe that the relative P/E will rise to 1.25, whereas the market P/E should be around 18 times earnings.

- Over the last year, the company generated an earnings per share of $3.50.
- Because there will be no significant change in the number of shares outstanding, the company's earnings are expected to grow by 20% next year.
- The stock would trade at a P/E of around 20 times earnings.
- The P/E approach is used to value this stock.

- Newco has yet to make a profit.
- You can't calculate a P/E ratio because the stock pays no dividends and you can't place a value on it.
- To see if you can find a way to value Newco, you need to look at other stocks in the same industry.

- Estimate the market value of Newco.
- If Newco was expected to grow much faster than the other companies, discuss how your estimate could change.

- World Wide Web Wares is an online retailer of small kitchen appliances and utensils.
- The firm has been around for a few years and has a nice market niche.
- It turned a small profit last year.
- You decided to take a closer look after doing some research on the company.

- You can use the average P/S ratio to put a value on 4W's stock since it will have 10 million shares outstanding.

- Chris looks for a way to invest his wealth.

- He was recently named the head writer for one of TV's top-rated sitcoms.
- Chris decided to set up an investment program on the advice of his father and manager, as he realized that his business is changeable.
- Chris will make half a million dollars this year.
- He decided to invest in speculative, high-growth stocks because of his age, income level, and desire to get as big a bang as possible from his investment dollars.

- Chris is working with a Beverly Hills broker to build up a diversified portfolio of speculative stocks.
- He was recently sent information by the broker.
- If Chris likes the numbers, she advised him to buy as many as 1,000 shares of the stock.

- There are 2.5 million shares of common stock outstanding.
- They pay no dividends and are currently being traded at $70 a share.
- The company has a net profit rate of 20%, and its stock has been trading at a P/E of 40 times earnings.
- The operating characteristics are expected to hold in the future.

- If all expectations hold up and Chris buys the stock at $70, determine his expected return on this investment.

- An Analysis of a high-Flying stock is an analysis of a security analyst with Lippman, Brickbats, and Shaft.
- C&I Medical Supplies, a company that has turned in an outstanding performance lately and has exhibited excellent growth potential, is one of the hottest issues on Wall Street.
- It pays a nominal annual dividend of $0.05 per share and has five million shares outstanding.
- C&I will be looked at more closely to assess its investment potential.

- The future prospects of the company are of paramount importance.

- Determine the average annual rate of sales growth over the past five years.

- Predict revenues for the year after that by using the average growth rate.

- Determine the company's net earnings and earnings per share for the next two years.

- Determine the expected future price of the stock at the end of the two-year period.

- 25% is a viable figure to use for a desired rate of return because of several factors.

- Future dividends and potential price appreciation are what PArtEE is interested in.
- A useful way to view stock value is that it is equal to the present value of all expected future dividends over an infinite time horizon.

- The dividend valuation model has evolved based on this concept.
- The zero-growth model, constant-growth model, and variable-growth model can be used.

- The Rhyhorn Company common stock has an intrinsic value that can be predicted using a variable-growth model.
- The dividends will grow at a variable rate over the next three years.
- The annual rate of growth in dividends is expected to stay there for the foreseeable future.
- Rhyhorn's earnings and dividends are expected to grow by 18%, by 14%, and by 9% over the next three years, before dropping to a 7% rate.
- Assume a minimum required rate of return of at least 12% for the risk profile of the firm.
- You can view the spreadsheet for this problem.

- The present value of dividends is determined during the initial variable-growth period.

- Rhyhorn stock's total intrinsic value can be determined by your calculations.

- In the beginning of the chapter, you read about the earnings announcement from HP in which they reported earnings per share of $1.85 for the quarter.
- Let's assume that earnings for the year were four times as much, or $7.40 per share.
- The average P/E for stocks in the US was close to 15 at that time.

- The price of HP was about $73 after the earnings announcement.

- HP could have paid out all of its earnings as a dividend.
- If investors expected the firm to continue doing that forever, and the company was not reinvesting any earnings, there would be no growth in dividends.

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