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Problem Set 2

This document contains 16 questions from a problem set on financial management. The questions cover topics such as the purpose of preemptive rights for stockholders, valuing stocks using discounted dividend and corporate valuation models, valuing perpetual preferred stocks, and calculating rates of return on preferred stocks.

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54 views

Problem Set 2

This document contains 16 questions from a problem set on financial management. The questions cover topics such as the purpose of preemptive rights for stockholders, valuing stocks using discounted dividend and corporate valuation models, valuing perpetual preferred stocks, and calculating rates of return on preferred stocks.

Uploaded by

laiba
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Problem Set 2 – FIN 401 Financial Management

Q.1 It is frequently stated that the one purpose of the preemptive right is to allow individuals to maintain
their proportionate share of the ownership and control of a corporation.
a. How important do you suppose control is for the average stockholder of a firm whose shares are traded
on the New York Stock Exchange?
b. Is the control issue likely to be of more importance to stockholders of publicly owned or closely held
(private) firms? Explain.

Q.2 Is the following equation correct for finding the value of a constant growth stock? Explain.

Q.3 If you bought a share of common stock, you would probably expect to receive dividends plus an
eventual capital gain. Would the distribution between the dividend yield and the capital gains yield be
influenced by the firm’s decision to pay more dividends rather than to retain and reinvest more of its
earnings? Explain.

Q.4 Two investors are evaluating GE’s stock for possible purchase. They agree on the expected value of
D1 and on the expected future dividend growth rate. Further, they agree on the riskiness of the stock.
However, one investor normally holds stocks for 2 years, while the other holds stocks for 10 years. On the
basis of the type of analysis done in this chapter, should they both be willing to pay the same price for
GE’s stock? Explain.

Q.5 A bond that pays interest forever and has no maturity is a perpetual bond. In what respect is a
perpetual bond similar to a no-growth common stock? Are there preferred stocks that are evaluated
similarly to perpetual bonds and other preferred issues that are more like bonds with finite lives? Explain.

Q.6 Discuss the similarities and differences between the discounted dividend and corporate valuation
models.

Q.7 This chapter discusses the discounted dividend and corporate valuation models for valuing common
stocks. Three alternative approaches, the P/E multiple, Enterprise Values, and EVA approaches, were
presented. Explain each approach and how you might use each one to value a common stock.
Q.8 How do non-operating assets impact a firm’s valuation using the corporate valuation model?

Q.9 Weston Corporation just paid a dividend of $1.00 a share (i.e., D0 5 $1.00). The dividend is expected
to grow 12% a year for the next 3 years and then at 5% a year thereafter. What is the expected dividend
per share for each of the next 5 years?

Q.10 CONSTANT GROWTH VALUATION Tresnan Brothers is expected to pay a $1.80 per share dividend at
the end of the year (i.e., D1 5 $1.80). The dividend is expected to grow at a constant rate of 4% a year.
The required rate of return on the stock, rs, is 10%. What is the stock’s current value per share?

Q.11 CONSTANT GROWTH VALUATION Holtzman Clothiers’s stock currently sells for $38.00 a share. It just
paid a dividend of $2.00 a share (i.e., D0 5 $2.00). The dividend is expected to grow at a constant rate of
5% a year. What stock price is expected 1 year from now? What is the required rate of return?

Q.12 NONCONSTANT GROWTH VALUATION Holt Enterprises recently paid a dividend, D0, of $2.75. It
expects to have nonconstant growth of 18% for 2 years followed by a constant rate of 6% thereafter. The
firm’s required return is 12%.
a. How far away is the horizon date?
b. What is the firm’s horizon, or continuing, value?
c. What is the firm’s intrinsic value today, P ⁄0?

Q.13 CORPORATE VALUATION Scampini Technologies is expected to generate $25 million in free cash flow
next year, and FCF is expected to grow at a constant rate of 4% per year indefinitely. Scampini has no debt
or preferred stock, and its WACC is 10%. If Scampini has 40 million shares of stock outstanding, what is
the stock’s value per share?

Q.14 PREFERRED STOCK VALUATION Farley Inc. has perpetual preferred stock outstanding that sells for
$30 a share and pays a dividend of $2.75 at the end of each year. What is the required rate of return?

Q.15 PREFERRED STOCK RATE OF RETURN What will be the nominal rate of return on a perpetual preferred
stock with a $100 par value, a stated dividend of 10% of par, and a current market price of (a) $61, (b)
$90, (c) $100, and (d) $138?

Q.16 PREFERRED STOCK VALUATION Earley Corporation issued perpetual preferred stock with an 8%
annual dividend. The stock currently yields 7%, and its par value is $100.
a. What is the stock’s value?
b. Suppose interest rates rise and pull the preferred stock’s yield up to 9%. What is its
new market value?

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