# Terminal or horizon value of operation

Chapter 13 Problem 13-6, 13-7, 13-8

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13-6:

Brooks Enterprises has never paid a dividend. Free cash flow is projected to be

\$80,000 and \$100,000 for the next 2 years, respectively; after the second year, FCF is expected to grow at a constant rate of 8%. The companys weighted average cost of capital is 12%.

a.

What is the terminal, or horizon, value of operations? (Hint: Find the value of all free cash flows beyond Year 2 discounted back to Year 2.)

b. Calculate the value of Brookss operations.

13- 7

Dozier Corporation is a fast growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Doziers weighted average cost of capital is WACC = 13%.

YEAR

1 2 3

Free Cash Flow (\$millions) -\$20 \$30 \$40

a.)

What is Doziers terminal, or horizon, value? (Hint: Find the value of all free cash flows beyond year 3 discounted back to Year 3.)

b.)

What is the current value of operations for Dozier?

c.)

Suppose Dozier has \$10 million in marketable securities, \$100 million in debt, and 10 million shares of stock. What is the intrinsic price per share?

13.8

The balance sheet of Hutter Amalgamated is shown below. If the 12/31/2010 value of operations is \$756 million, what is the 12/31/2010 intrinsic market value of equity?

Assets Liabilities and Equity

Cash \$20.0 Accounts Payable \$19.0

Marketable securities 77.0 Notes Payable 151.0

Accounts receivable 100.0 Accruals 51.0

Inventories 200.0 Total current liabilities \$221.0

Total current assets \$397.0 Long term bonds 190.0

Net Plant and equipment 279.0 Preferred stock 76.0

Common stock

(par plus PIC) 100.0

Retained earnings 89.0

Common equity \$189.0

Total Assets \$676.0 Total liabilities \$676.0

Chapter 4 Problem 4-4, 4-5, 4-20, 4-22

4-4:

If you deposit money today in an account that pays 6.5% annual interest, how long will it take to double your money?

4-5:

You have \$42,180.53 in a brokerage account, and you plan to deposit an additional \$5,000 at the end of every future year until your account totals \$250,000. You expect to earn 12% annually on the account. How many years will it take to reach your goal?

4-20:

a. Set up an amortization schedule for a \$25,000 loan to be repaid in equal instalments at the end of each of the next 5 years. The interest rate is 10%.

b. How large must each annual payment be if the loan is for \$50,000? Assume that the interest rate remains at 10% and that the loan is still paid off over 5 years.

c. How large must each payment be if the loan is for \$50,000, the interest rate is 10%, and the loan is paid off in equal installments at the end of each of the next 10 years? This loan is for the same amount as the loan in part b, but the payments are spread out over twice as many periods. Why are these payments not half as large as the payments on the loan in part b?

4-22:

Washington-Pacific invested million to buy a tract of land and plant some young pine trees. The trees can be harvested in 10 years, at which to sell the forest at an expected price of \$8 million. What is W-Ps expected rate of return?

Chapter 5 Problem 5-15, 5-21

5-15;

Absalom Motorss 14% coupon rate, semiannual payment, \$1,000 par value bonds that mature in 30 years are callable 5 years from now at a price of \$1,050. The bonds sell at a price of \$1,353.54, and the yield curve is flat. Assuming that interest rates in the economy are expected to remain at their current level, what is the best estimate of the nominal interest rate on new bonds?

5-21:

Suppose Hillard Manufacturing sold an issue of bonds with a 10-year maturity, a \$1,000 par value, a 10% coupon rate, and semiannual interest payments.

a. Two years after the bonds were issued, the going rate of interest on bonds such as these fell to 6%. At what price would the bonds sell?

b. Suppose that, 2 years after the initial offering, the going interest rate had risen to 12%. At what price would the bonds sell?

c. Suppose, as in part a, that interest rates fell to 6%, 2 years after the issue date. Suppose further that the interest rate remained at 6% for the next 8 years. What would happen to the price of the bonds over time?

Chapter 6 Problem 6-4, 6-10

6-4:

A stock’s returns have the following distribution:

Demand for Probability of Rate of return
Company’s this Demand if this demand
Products Occuring Occurs

Weak 0.1 (50%)
Below Average 0.2 (5)
Average 0.4 16
Above average 0.2 25
Strong 0.1 60
1.0
Calculate the stock’s expected return, standard deviation, and coefficient of variation.

6-10:

You have a \$2 million portfolio consisting of a \$100,000 investment in each of 20different stocks. The portfolio has a beta of 1.1. You are considering selling \$100,000 worth of one stock with a beta of 0.9 and using the proceeds to purchase another stock with a beta of 1.4. What will the portfolios new beta be after these transactions?

Chapter 7 Problem 7-4, 7-10

7-4:

Nicks Enchiladas Incorporated has preferred stock outstanding that pays a dividend of \$5 at the end of each year. The preferred sells for \$50 a share. What is the stocks required rate of return?

7-10:

The beta coefficient for Stock C is bC = 0.4 and that for Stock D is bD = 0.5. (Stock Ds beta is negative, indicating that its rate of return rises whenever returns on most other stocks fall. There are very few negative-beta stocks, although collection agency and gold mining stocks are sometimes cited as examples.)

a.

If the risk-free rate is 9% and the expected rate of return on an average stock is 13%, what are the required rates of return on Stocks C and D?

b.

For Stock C, suppose the current price, P0, is \$25; the next expected dividend,D1, is \$1.50; and the stocks expected constant growth rate is 4%. Is the stock in equilibrium? Explain, and describe what would happen if the stock were not in equilibrium.

Chapter 8 Problem 8-4, 8-5, 8-6

8-4:

The current price of a stock is \$33, and the annual risk-free rate is 6%. A call option with a strike price of \$32 and with 1 year until expiration has a current value of \$6.56. What is the value of a put option written on the stock with the same exercise price and expiration date as the call option?

8-5:

Use the Black-Scholes Model to find the price for a call option with the following inputs: (1) current stock price is \$30, (2) strike price is \$35, (3) time to expiration is 4 months, (4) is 5%, and (5) variance of stock return is 0.25.

8-6:

The current price of a stock is \$20. In 1 year, the price will be either \$26 or \$16. The annual risk-free rate is 5%. Find the price of a call option on the stock that has a strike price of \$21 and that expires in 1 year. (Hint: Use daily compounding.)

Chapter 9 Problem 9-3, 9-8, 9-13

9-3:

Duggins Veterinary Supplies can issue perpetual preferred stock at a price of \$50 a share with an annual dividend of \$4.50 a share. Ignoring flotation costs, what is the companys cost of preferred stock, rps?

9-8;

David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the companys outstanding bonds is 9%, and the companys tax rate is 40%. Ortizs CFO has calculated the companys WACC as 9.96%. What is the companys cost of equity capital?

9-13:

Messman Manufacturing will issue common stock to the public for \$30. The expected dividend and the growth in dividends are \$3.00 per share and 5%, respectively. If the flotation cost is 10% of the issues gross proceeds, what is the cost of external equity, re?

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