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Question
Your boss, Sally Maloney, treasurer of Fred Clark Enterprises (FCE), asked you to help her estimate the intrinsic value of the company's stock. FCE just paid a dividend of $1.00, and the stock now sells for $13.00 per share. Sally asked a number of security analysts what they believe FCE's future dividends will be, based on their analysis of the company. The consensus is that the dividend will be increased by 10% during Years 1 to 3, and it will be increased at a rate of 5% per year in Year 4 and thereafter. Sally asked you to use that information to estimate the required rate of return on the stock, rs, and she provided you with the following template for use in the analysis.
Estimated rs = 10.00% (must be changed to force Calculated Price to equal the Actual Market Price)
Actual Market Price, P0: $13.00
u200b
Rapid growth Normal growth
Year 0 1 2 3 4 5
Dividend growth rate (insert correct values) u200b 10% 10% 10% 5% 5%
Calculated dividends (D0 has been paid) u200b $1.00 ? ? ? ? ?
HV3 = D4/(rs - g4). Find using Estimated rs. u200b u200b u200b ? u200b u200b
Total CFs u200b ? ? ?
PVs of CFs when discounted at Estimated rsu200b ? ? ?
Calculated Price = P0 = Sum of PVs =
u200b
u200b $0.00
u200b
u200b A positive number will be here when dividends are estimated.
The Calculated Price will equal the Actual Market Price once the correct rs has been found.
Sally told you that the growth rates in the template were just put in as a trial, and that you must replace them with the analysts' forecasted rates to get the correct forecasted dividends and then the estimated HV. She also notes that the estimated value for rs, at the top of the template, is also just a guess, and you must replace it with a value that will cause the Calculated Price shown at the bottom to equal the Actual Market Price. She suggests that, after you have put in the correct dividends, you can manually calculate the price, using a series of guesses as to the Estimated rs. The value of rs that causes the calculated price to equal the actual price is the correct one. She notes, though, that this trial-and-error process is quite tedious, and that the correct rs could be found much faster with a simple Excel model, especially if you use Goal Seek. What is the value of rs?
a. 15.47%
b. 10.64%
c. 16.46%
d. 12.20%
e. 14.19%
Answer
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Related questions
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0 1 2 3 4
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Refer to Exhibit 4.1. What is the firm's total debt to total capital ratio? Do not round your intermediate calculations.
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Q:
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a. True
b. False
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a. True
b. False
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a. True
b. False
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a. True
b. False
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It is possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B.
a. True
b. False
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u200b u200b
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Annual operating costs $30,000
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Q:
Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?
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b. The interest rate today on a 2-year bond should be approximately 6%.
c. The interest rate today on a 2-year bond should be approximately 7%.
d. The interest rate today on a 3-year bond should be approximately 7%.
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Q:
Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?
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Q:
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Q:
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Q:
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a. 1, 3, 4, 6
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c. 1, 2, 3, 4, 6
d. 1, 2, 3, 4, 5, 6
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Q:
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c. A 10-year coupon bond would have more reinvestment risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of reinvestment risk.
d. A 10-year coupon bond would have more price risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of price risk.
e. If their maturities and other characteristics were the same, a 5% coupon bond would have less price risk than a 10% coupon bond.
Q:
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Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.
e. Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
Q:
Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
Q:
When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage declines in the loan's later years.
a. True
b. False
Q:
As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).
a. True
b. False