Financial Planning Problems

9-1. Assume Evco, Inc., has a current price of $50 and will pay a $2 dividend in one year, and its

equity cost of capital is 15%. What price must you expect it to sell for right after paying the

dividend in one year in order to justify its current price?

9-2. Anle Corporation has a current price of $20, is expected to pay a dividend of $1 in one year, and

its expected price right after paying that dividend is $22.

a. What is Anle’s expected dividend yield?

b. What is Anle’s expected capital gain rate?

c. What is Anle’s equity cost of capital?

9-3. Suppose Acap Corporation will pay a dividend of $2.80 per share at the end of this year and $3

per share next year. You expect Acap’s stock price to be $52 in two years. If Acap’s equity cost

of capital is 10%:

a. What price would you be willing to pay for a share of Acap stock today, if you planned to

hold the stock for two years?

b. Suppose instead you plan to hold the stock for one year. What price would you expect to be

able to sell a share of Acap stock for in one year?

c. Given your answer in part (b), what price would you be willing to pay for a share of Acap

stock today, if you planned to hold the stock for one year? How does this compare to you

answer in part (a)?

9-4. Krell Industries has a share price of $22 today. If Krell is expected to pay a dividend of $0.88 this

year, and its stock price is expected to grow to $23.54 at the end of the year, what is Krell’s

dividend yield and equity cost of capital?

9-5. NoGrowth Corporation currently pays a dividend of $2 per year, and it will continue to pay this

dividend forever. What is the price per share if its equity cost of capital is 15% per year?

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9-6. Summit Systems will pay a dividend of $1.50 this year. If you expect Summit’s dividend to grow

by 6% per year, what is its price per share if its equity cost of capital is 11%?

9-7. Dorpac Corporation has a dividend yield of 1.5%. Dorpac’s equity cost of capital is 8%, and its

dividends are expected to grow at a constant rate.

a. What is the expected growth rate of Dorpac’s dividends?

b. What is the expected growth rate of Dorpac’s share price?

9-8. Kenneth Cole Productions (KCP), suspended its dividend at the start of 2009. Suppose you do

not expect KCP to resume paying dividends until 2011.You expect KCP’s dividend in 2011 to be

$0.40 per year (paid at the end of the year), and you expect it to grow by 5% per year thereafter.

If KCP’s equity cost of capital is 11%, what is the value of a share of KCP at the start of 2009?

9-9. DFB, Inc., expects earnings this year of $5 per share, and it plans to pay a $3 dividend to

shareholders. DFB will retain $2 per share of its earnings to reinvest in new projects with an

expected return of 15% per year. Suppose DFB will maintain the same dividend payout rate,

retention rate, and return on new investments in the future and will not change its number of

outstanding shares.

a. What growth rate of earnings would you forecast for DFB?

b. If DFB’s equity cost of capital is 12%, what price would you estimate for DFB stock?

c. Suppose DFB instead paid a dividend of $4 per share this year and retained only $1 per

share in earnings. If DFB maintains this higher payout rate in the future, what stock price

would you estimate now? Should DFB raise its dividend?

9-10. Cooperton Mining just announced it will cut its dividend from $4 to $2.50 per share and use the

extra funds to expand. Prior to the announcement, Cooperton’s dividends were expected to grow

at a 3% rate, and its share price was $50. With the new expansion, Cooperton’s dividends are

expected to grow at a 5% rate. What share price would you expect after the announcement?

(Assume Cooperton’s risk is unchanged by the new expansion.) Is the expansion a positive NPV

investment?

9-11. Gillette Corporation will pay an annual dividend of $0.65 one year from now. Analysts expect

this dividend to grow at 12% per year thereafter until the fifth year. After then, growth will level

off at 2% per year. According to the dividend-discount model, what is the value of a share of

Gillette stock if the firm’s equity cost of capital is 8%?

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9-12. Colgate-Palmolive Company has just paid an annual dividend of $0.96. Analysts are predicting

an 11% per year growth rate in earnings over the next five years. After then, Colgate’s earnings

are expected to grow at the current industry average of 5.2% per year. If Colgate’s equity cost of

capital is 8.5% per year and its dividend payout ratio remains constant, what price does the

dividend-discount model predict Colgate stock should sell for?

9-13. What is the value of a firm with initial dividendDiv, growing fornyears (i.e., until yearn+ 1) at

rateg1and after that at rateg2forever, when the equity cost of capital isr?

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9-14. Halliford Corporation expects to have earnings this coming year of $3 per share. Halliford plans

to retain all of its earnings for the next two years. For the subsequent two years, the firm will

retain 50% of its earnings. It will then retain 20% of its earnings from that point onward. Each

year, retained earnings will be invested in new projects with an expected return of 25% per year.

Any earnings that are not retained will be paid out as dividends. Assume Halliford’s share count

remains constant and all earnings growth comes from the investment of retained earnings. If

Halliford’s equity cost of capital is 10%, what price would you estimate for Halliford stock?

9-15. Suppose Cisco Systems pays no dividends but spent $5 billion on share repurchases last year. If

Cisco’s equity cost of capital is 12%, and if the amount spent on repurchases is expected to grow

by 8% per year, estimate Cisco’s market capitalization. If Cisco has 6 billion shares outstanding,

what stock price does this correspond to?

9-16. Maynard Steel plans to pay a dividend of $3 this year. The company has an expected earnings

growth rate of 4% per year and an equity cost of capital of 10%.

a. Assuming Maynard’s dividend payout rate and expected growth rate remains constant, and

Maynard does not issue or repurchase shares, estimate Maynard’s share price.

b. Suppose Maynard decides to pay a dividend of $1 this year and use the remaining $2 per

share to repurchase shares. If Maynard’s total payout rate remains constant, estimate

Maynard’s share price.

c. If Maynard maintains the dividend and total payout rate given in part (b), at what rate are

Maynard’s dividends and earnings per share expected to grow?

9-17. Benchmark Metrics, Inc. (BMI), an all-equity financed firm, just reported EPS of $5.00 per

share for 2008. Despite the economic downturn, BMI is confident regarding its current

investment opportunities. But due to the financial crisis, BMI does not wish to fund these

investments externally. The Board has therefore decided to suspend its stock repurchase plan

and cut its dividend to $1 per share (vs. almost $2 per share in 2007), and retain these funds

instead. The firm has just paid the 2008 dividend, and BMI plans to keep its dividend at $1 per

share in 2009 as well. In subsequent years, it expects its growth opportunities to slow, and it will

still be able to fund its growth internally with a target 40% dividend payout ratio, and

reinitiating its stock repurchase plan for a total payout rate of 60%. (All dividends and

repurchases occur at the end of each year.)

Suppose BMI’s existing operations will continue to generate the current level of earnings per

share in the future. Assume further that the return on new investment is 15%, and that

reinvestments will account for all future earnings growth (if any). Finally, assume BMI’s equity

cost of capital is 10%.

a. Estimate BMI’s EPS in 2009 and 2010 (before any share repurchases).

b. What is the value of a share of BMI at the start of 2009?

9-18. Heavy Metal Corporation is expected to generate the following free cash flows over the next five

years:

After then, the free cash flows are expected to grow at the industry average of 4% per year.

Using the discounted free cash flow model and a weighted average cost of capital of 14%:

a. Estimate the enterprise value of Heavy Metal.

b. If Heavy Metal has no excess cash, debt of $300 million, and 40 million shares outstanding,

estimate its share price.