Problem: Each of the six firms in the table below is expected to pay the listed dividend payment every year in perpetuity.
Firm Dividend ($million) Cost of capital (% /year)
S1 10 8
S2 10 12
S3 10 14
B1 100 8
B2 100 12
B3 100 14
Problem 1: Using the cost of capital in the table, calculate the market value of each firm.
Problem 2: Rank the three S firms by their market values and look at how their cost of capital is ordered. What would be the expected return for a self financing portfolio that went long on the firm with the largest market value and shorted the firm with the lowest market value? (the expected return of a self financing portfolio is the weighted average return of the consituent securities. Repeat using B firms.
Problem 3: Rank all six firms by their market values. How does this ranking order the cost of capital? What would be the expected return for a self financing portfolio that went long on the firm with the largest market value and shorted the firm with the lowest market value?
Problem 4: Repeat part ( c) but rank the firms by the dividend yield instead of the market value. What can you conclude about the dividend yield ranking compared to the market value ranking?