Exam 10: Valuation Concepts

The Hart Mountain Company has recently discovered a new type of kitty litter which is extremely absorbent.It is expected that the firm will experience (beginning now) an unusually high growth rate (20 percent) during the period (3 years) it has exclusive rights to the property where the raw material used to make this kitty litter is found.However, beginning with the fourth year the firm's competition will have access to the material, and from that time on the firm will achieve a normal growth rate of 8 percent annually.During the rapid growth period, the firm's dividend payout ratio (percent of EPS paid as dividends) will be relatively low (20 percent) in order to conserve funds for reinvestment.However, the decrease in growth in the fourth year will be accompanied by an increase in dividend payout to 50 percent.Last year's earnings were E₀ = $2.00 per share, and the firm's required return is 10 percent.What should be the current price of the common stock?

An 8 percent annual coupon, noncallable bond has ten years until it matures and a yield to maturity of 9.1 percent.What should be the price of a 10-year bond of equal risk which pays an 8 percent semiannual coupon? Assume both bonds have a maturity value of $1,000.

Suppose that you read in The Wall Street Journal that a bond has a coupon rate of 9 percent, a price of 71 3/8, and pays interest annually.Rounded to the nearest whole percent, what would be the bond's "current" yield?

The realized rate of return on a stock is always equal to expected rate of return when the stock is purchased at the current market value.

The Florida Boosters Association has decided to build new bleachers for the football field.Total costs are estimated to be $1 million, and financing will be through a bond issue of the same amount.The bond will have a maturity of 20 years, a coupon rate of 8 percent, and has annual payments.In addition, the Association must set up a reserve to pay off the loan by making 20 equal annual payments into an account which pays 8 percent, annual compounding.The interest-accumulated amount in the reserve will be used to retire the entire issue at its maturity 20 years hence.The Association plans to meet the payment requirements by selling season tickets at $10 net profit per ticket.How many tickets must be sold each year to service the debt, i.e., to meet the interest and principal repayment requirements?

Assume that you own a hundred $1,000 par value bonds, with a total face value of $100,000.These bonds have a 4 percent coupon, pay interest semiannually, and have 5 years remaining until they mature.New bonds with the same risk and maturity provide yields to maturity of 14 percent.You are considering selling your bonds and depositing the proceeds in a savings account which pays interest at a rate of 6 percent, annual compounding.If you do make the transaction, you will liquidate the savings account by making 5 equal withdrawals, the first coming 1 year from now.What will be the amount of each annual withdrawal?

Suppose a stock is not currently paying dividends, and its management has announced that it will not pay a dividend for at least 5 years, but that it does expect to start paying dividends sometime in the future.Under these conditions, which of the following statements is correct?

A $1,000 face value bond with a $100 annual interest payment with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates were greater than 11%.

Which of the following statements is most correct?

In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures to a market value basis.KJM Corporation's balance sheet as of January 1, 2010 is as follows: The bonds have a 4 percent coupon rate, payable semiannually, and a par value of $1,000.They mature on January 1, 2020.The yield to maturity is 12 percent, so the bonds now sell below par.What is the current market value of the firm's debt?

Which of the following statements is correct?

U.S.Delay Corporation, a subsidiary of the Postal Service, must decide whether to issue zero coupon bonds or quarterly payment bonds to fund construction of new facilities.The 1,000 par value quarterly payment bonds would sell at $795.54, have a 10 percent annual coupon rate, and mature in ten years.At what price would the zero coupon bonds with a maturity of 10 years have to sell to earn the same effective annual rate as the quarterly payment bonds?

Eastern Auto Parts' last dividend was D₀ = $0.50, and the company expects to experience no growth for the next 2 years.However, Eastern will grow at an annual rate of 5 percent in the third and fourth years, and, beginning with the fifth year, it should attain a 10 percent growth rate which it should sustain thereafter.Eastern has a required rate of return of 12 percent.What should be the present price per share of Eastern common stock?

You have a chance to purchase a perpetual security that has a stated annual payment (cash flow) of $50.However, this is an unusual security in that the payment will increase at an annual rate of 5 percent per year; this increase is designed to help you keep up with inflation.The next payment to be received (your first payment, due in 1 year) will be $52.50.If your required rate of return is 15 percent, how much should you be willing to pay for this security?

Assume that McDonald's and Burger King have similar $1,000 par value bond issues outstanding.The bonds are equally risky.The Burger King bond has interest payments of $80 paid annually and matures 20 years from today.The McDonald's bond has interest payments of $80 paid semiannually, and it also matures in 20 years.If the simple required rate of return, r_d, is 12 percent, semiannual basis, for both bonds, what is the difference in current market prices of the two bonds?

Which of the following statements about bonds is most correct?

All else equal, a higher coupon rate on a bond results in a higher market price for the bond.

The cash flows associated with common stock are difficult to evaluate due to the uncertainty and variability associated with them.

Garcia Inc.has a current dividend of $3.00 per share (D₀ = $3.00).Analysts expect that the dividend will grow at a rate of 25 percent a year for the next three years, and thereafter it will grow at a constant rate of 10 percent a year.The company's cost of equity capital is estimated to be 15 percent.What is the current stock price of Garcia Inc.?

Gourmet Cheese Shoppe opened at the end of 2001.In its first full year of operations, 2002, earnings per share (EPS) was $0.26.Four years later, in 2005, EPS was up to $0.38, and 7 years after that, in 2012, EPS was up to $0.535.It appears that the first 4 years represented a supernormal growth situation and since then a more normal growth rate has been sustained.What are the rates of growth for the earlier period and for the later period?