Problem of Chapter 9.
Taussig Technologies Corporation (TTC) has been growing at a rate of 20% per year in recent years. This same growth rate is expected to last for another 2 years, then to decline to gn = 6%.
a. If D0 = $1.60 and rs = 10%, what is TTC's stock worth today? What are its expected dividend and capital gains yields at this time, that is, during Year 1?
1. Find the price today.
2. Find the expected dividend yield.
Recall that the expected dividend yield is equal to the next expected annual dividend divided by the price at the beginning of the period.
3. Find the expected capital gains yield.
The capital gains yield can be calculated by simply subtracting the dividend yield from the total expected return.
Alternatively, we can recognize that the capital gains yield measures capital appreciation, hence solve for the price in one year, then divide the change in price from today to one year from now by the current price.
To find the price one year from now, we will have to find the present values of the horizon value and second year dividend to time period one.
b. Now assume that TTC's period of supernormal growth is to last for 5 years rather than 2 years. How would this affect the price, dividend yield, and capital gains yield?
1. Find the price today.
Part 2. Finding the expected dividend yield.
Part 3. Finding the expected capital gains yield.
c. What will TTC's dividend and capital gains yields be once its period of supernormal growth ends?
(Hint: These values will be the same regardless of whether you examine the case of 2 or 5 years of supernormal growth; the calculations are easy.)
We used the 5-year supernormal growth scenario for this calculation, but ultimately it does not matter which example you use, as they both yield the same result.
Upon reflection, we see that these calculations were unnecessary because the constant growth assumption holds that the long-term growth rate is the dividend growth rate and the capital gains yield, hence we could have simply subtracted the long-run growth rate from the required return to find the dividend yield.
d. TTC recently introduced a new line of products that has been wildly successful. On the basis of this success and anticipated future success, the following free cash flows were projected:
After the 10th year, TTC's financial planners anticipate that its free cash flow will grow at a constant rate of 6%. Also, the firm concluded that the new product caused the WACC to fall to 9%. The market value of TTC's debt is $1,200 million, it uses no preferred stock, and there are 20 million shares of common stock outstanding. Use the corporate valuation model approach to value the stock.
The price as estimated by the corporate valuation method differs from the discounted dividends method because different assumptions are built into the two situations. If we had projected financial statements, found both dividends and free cash flow from those projected statements, and applied the two methods, then the prices produced would have been identical. As it stands, though, the two prices were based on somewhat different assumptions, hence different prices were obtained. Note especially that in the FCF model we assumed a WACC of 9% versus 10% for the discounted dividend model. That would obviously tend to
raise the price.
Attachment:- Chapter9Excel-.rar
Problem of chapter 10
Here is the condensed 2011 balance sheet for Skye Computer Company (in thousands of dollars):
CONDENSED BALANCE SHEET FOR SKYE COMPUTER COMPANY
Skye's earnings per share last year were $3.20. The common stock sells for $55.00, last year's dividend (D0) was $2.10, and a flotation cost of 10% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 9%. Skye's preferred stock pays a dividend of $3.30 per share, and its preferred stock sells for $30 per share. The firm can issue long-term debt at an interest rate (or before-tax cost) of 10%, and its marginal tax rate is 35%. The firm's currently outstanding 10% annual coupon rate long-term debt sells at par value.
The market risk premium is 5%, the risk-free rate is 6%, and Skye's beta is 1.516. In its cost of capital calculations, the company considers only long-term capital, hence, it disregards current liabilities for calculating its WACC.
a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity.
b. Now calculate the cost of common equity from retained earnings using the CAPM method.
c. What is the cost of new common stock based on the CAPM? (Hint: Find the difference between re and rs as determined by the DCF method and add that differential to the CAPM value for rs.)
d. If Skye continues to use the same market value capital structure, what is the firm's WACC assuming that
(1) it uses only retained earnings for equity? (2) If it expands so rapidly that it must issue new common stock?
(1) WACC using retained earnings
(2) WACC using new common stock
Attachment:- Chapter10Excel-.rar
Problem of chapter 11
Your division is considering two projects. Its WACC is 10%, and the projects' after-tax cash flows (in millions of dollars) would be as follows:
a. Calculate the projects' NPVs, IRRs, MIRRs, regular paybacks, and discounted paybacks.
b. If the two projects are independent, which project(s) should be chosen?
c. If the two projects are mutually exclusive and the WACC is 10%, which project(s) should be chosen?
Attachment:- Chapter11Excel--.rar