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    Nanyang Business School AB1201 Financial Management Tutorial 6: Stocks and Their Valuation and Stock Market Efficiency (Common Questions)

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    This document contains sample questions and answers related to stock valuation and market efficiency from the AB1201 Financial Management tutorial. It includes examples of calculating stock prices using different dividend growth rates, valuing preferred stock, estimating intrinsic value using P/E multiples, and valuing stocks with changing dividend growth over time. Sample self-practice questions are also provided at the end related to valuing stocks with non-constant dividend growth and calculating portfolio weights.

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    Nanyang Business School AB1201 Financial Management Tutorial 6: Stocks and Their Valuation and Stock Market Efficiency (Common Questions)

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    This document contains sample questions and answers related to stock valuation and market efficiency from the AB1201 Financial Management tutorial. It includes examples of calculating stock prices using different dividend growth rates, valuing preferred stock, estimating intrinsic value using P/E multiples, and valuing stocks with changing dividend growth over time. Sample self-practice questions are also provided at the end related to valuing stocks with non-constant dividend growth and calculating portfolio weights.

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    This document contains sample questions and answers related to stock valuation and market efficiency from the AB1201 Financial Management tutorial. It includes examples of calculating stock prices using different dividend growth rates, valuing preferred stock, estimating intrinsic value using P/E multiples, and valuing stocks with changing dividend growth over time. Sample self-practice questions are also provided at the end related to valuing stocks with non-constant dividend growth and calculating portfolio weights.

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    297 views4 pages

    Nanyang Business School AB1201 Financial Management Tutorial 6: Stocks and Their Valuation and Stock Market Efficiency (Common Questions)

    Uploaded by

    asdsadsa
    This document contains sample questions and answers related to stock valuation and market efficiency from the AB1201 Financial Management tutorial. It includes examples of calculating stock prices using different dividend growth rates, valuing preferred stock, estimating intrinsic value using P/E multiples, and valuing stocks with changing dividend growth over time. Sample self-practice questions are also provided at the end related to valuing stocks with non-constant dividend growth and calculating portfolio weights.

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    of 4

    Strictly for course AB1201 internal circulation only.

    Nanyang Business School


    AB1201 Financial Management
    Tutorial 6: Stocks and Their Valuation and Stock Market Efficiency
    (Common Questions)
    Questions 1 to 5 will be presented by students while Question 6 will be presented by instructors.

    1) Constant growth. Investors require a 15% rate of return on Levine Companys stock (that is, rs
    = 15%).
    a) What is its value if the previous dividend was D0 = $2 and investors expect dividends to grow
    at a constant annual rate of (1) -5%, (2) 0%, (3) 5%, or (4) 10%?
    b) Is it reasonable to think that a constant growth stock could have g > rs? Explain.

    2) Declining growth. Martell Mining Companys ore reserves are being depleted, so its sales are
    falling. Also, because its pit is getting deeper each year, its costs are rising. As a result, the
    companys earnings and dividends are declining at the constant rate of 5% per year. If D0 = $5
    and rs = 15%, would you buy Martell Minings stock? If so, what is the value of the stock? What
    is the expected capital gains and dividend yield during the first year, second year, and third year?
    Assume the stock is trading at its intrinsic value.

    3) Calculation of g and EPS. Sidman Products common stock currently sells for $60.00 a share.
    The firm is expected to earn $5.40 per share this year and to pay a year-end dividend of $3.60.
    a) If investors require a 9% return and the market is in equilibrium, what is the expected growth
    rate, g?
    b) If Sidman continues with the same payout ratio, calculate the returns on retained earnings that
    Sidman achieves.

    4) Preferred stock valuation. Lippo Ltd. has perpetual preferred stock outstanding with a par
    value of $100. The stock pays a quarterly dividend of $2, and its current price is $80.
    a) What is its nominal annual rate of return?
    b) What is its effective rate of return?

    5) Firm Multiples Method. Look up the P/E ratio of Google on Yahoo! Finance. Look up the EPS
    of Yahoo! Inc. Based on the P/E ratio of Google, estimate the intrinsic value of Yahoo! Inc. Is
    the estimated intrinsic value very far from the actual stock price? Why do you think this is so?

    6) Nonconstant growth stock valuation. Taussig Technologies Corporation (TTC) has been
    growing at a rate of 20% per year in recent years. This same growth rate is expected to last for
    another 2 years, then decline to 6% per year forever. Assume the stock is trading at its intrinsic
    value.
    a) If D0 = $1.60 and rs = 10%, what is TTCs stock worth today? What are its expected dividend
    and capital gains yields during Year 1?
    b) Now assume that TTCs period of supernormal growth is to last for 5 years rather than 2 years.
    How would this affect the stock price, expected dividend yield, and expected capital gains yield?
    Answer in words only.
    c) What will TTCs expected dividend and capital gains yields be once its period of supernormal
    growth ends?
    d) Of what interest to investors is the changing relationship between dividend and capital gains
    yields over time?
    _____________________________________________________________________________

    Page 1 of 4
    Strictly for course AB1201 internal circulation only.

    Self-practice Questions

    Question1
    John, a stock analyst, is estimating the intrinsic value of Stocks A and B. He estimates that Stock A
    will pay a dividend $1.80 per share at the end of Year 1. Stock As dividend is expected to grow
    10% per year until the end of Year 4, after that the dividend is expected to grow forever at a
    constant rate of 6% per year. Stock A has a required rate of return of 12%. Stock B is expected to
    pay dividend of $2.00 per share at the end of Year 1. Stock Bs dividend is expected to grow
    forever at a constant rate of 7% per year. Stock B has a required rate of return of 13%.

    (i) What are the intrinsic values of Stocks A and B today?

    (ii) If John forms a portfolio of these two stocks, the beta of the portfolio is 1.267. Assume that
    the market risk premium and the risk-free rate are 6% and 5% respectively. What are the
    proportions of Stocks A and B held in the portfolio?

    Question 2
    Masier Corporation has been growing at a 10% rate, and it just paid a dividend of D0 = $2.50. The
    company expects its dividend growth rate to be 20% per year for the next 2 years. After this time,
    growth is expected to be constant at 7% forever. The companys equity beta and tax rate are 1.5
    and 35%, respectively. The market rate of return is 10%, and the risk-free rate is 6%. Assume the
    stock is in equilibrium.

    (i) What is the expected dividend yield today?

    (ii) What is the expected price at the end of year 3?

    Question 3
    Robin Corporation does not expect to pay any dividend for the next 2 years (i.e. end of Year 1 and
    Year 2). At the end of Year 3, the company expects to pay dividend of $0.50, and this dividend is
    expected to grow at a high growth rate of 35% per annum for 3 years, before achieving a long-run
    dividend growth rate of g%. The companys beta coefficient is 1.6. Risk-free rate is 4% per annum
    and market return is 8% per annum. If the intrinsic value of Robin Corporations shares is $14,
    what is the companys long-run dividend growth rate g?

    Answers to Self-practice Questions:

    Question 1

    (i) Stock A:

    Step 1: Find dividend stream

    D1 = $1.8, D2 = 1.8 x 1.1 = $1.98, D3 = 1.8 x 1.12 = $2.178, D4 = 1.8 x 1.13 = $2.3958

    Step 2: Find terminal value of stock as of t = 4

    Page 2 of 4
    Strictly for course AB1201 internal circulation only.

    D5 2.3958 1.06 2.5395


    P4 $42.3258
    rs g 0.12 0.06 0.06

    Step 3: Find intrinsic value at t = 0

    1.8 1.98 2.178 2.3958 42.3258


    P0 2
    $33.157
    1.12 (1.12) (1.12) 3 (1.12) 4 (1.12) 4

    Stock B:

    D1 2.00
    P0 $33.33
    rs g 0.13 0.07

    (ii) Method 1

    Step 1: Find required returns on portfolio given portfolio beta

    rP = rRF + RPM (bP) = 5% + 6% (1.267) = 12.60%

    Step 2: Since the required return on the portfolio is the weighted required return on Stock A and
    Stock B, we can set up the below equation

    rP = wA rA + (1 wA) rB

    12.6 = wA (12) + (1 wA) (13)

    wA = 40%, wB = 60%

    Method 2

    Step 1: Find the beta of Stocks A and B using the given required returns

    rA = rRF + RPM (bA)

    12 = 5 + 6 (bA)

    bA = 1.1667

    rB = rRF + RPM (bB)

    13 = 5 + 6 (bB)

    bA = 1.3333

    Step 2: Since portfolio beta is the weighted average beta of the component stock, we can set up the
    below equation:

    bP = wA bA + (1 wA) bB

    1.267 = wA (1.1667) + (1 wA) (1.3333)

    Page 3 of 4
    Strictly for course AB1201 internal circulation only.

    wA = 40%, wB = 60%

    Question 2
    (i) rs = 6 + (10-6)1.5 = 12%

    D1 = 2.50(1.2) = $3, D2 = 2.5(1.2)2 = $3.60, D3 = 3.60(1.07) = $3.8520

    3.8520
    P2 $77.04
    0.12 0.07

    3 3.60 77.04
    P0 2
    2.6786 2.8699 61.4158
    (1.12) (1.12) (1.12) 2
    = $66.9643

    D1 $3
    Dividend yield = 4.48%
    P0 $66.9643

    (ii) The expected price at the end of year 3


    D4 3.8520 (1.07) 4.1216
    P3 $82.43
    rS g 0.12 0.07 0.05
    Question 3

    0 rS 1 2 3 4 5 6 7
    |------------|------------|------------|------------|------------|-----------|-----------|---- - -
    P0=$14 $0.50 35% D4 35% D5 35% D6 g% D7

    rS = 4% + (8% - 4%) 1.6 = 10.4%

    D3 = 0.50
    D4 = 0.50 (1 + 35%) = 0.675
    D5 = 0.675 (1 + 35%) = 0.91125
    D6 = 0.91125 (1 + 35%) = 1.23019
    D7 = 1.23019 (1+g)

    PV6 = D7 / (rS g) = 1.23019 (1 + g) / (10.4% - g)

    14 = 0.5/(1+10.4%)3 + 0.675/(1+10.4%)4 + 0.91125/(1+10.4%)5


    + 1.23019/(1+10.4%)6 + 1.23019(1+g)/(10.4% - g)/(1+10.4%)6

    14 = 2.06107 + 0.67945(1+g)/(0.104 g)

    g = 4.46%

    Page 4 of 4

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