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Chapter 4: 19BP (page 324)
Stilley 91影视 bonds have four years left to maturity. Interest is paid annually, and the bonds have a \(1,000 par value and a coupon rate of 5 percent. If the price of the bond is \)841.51, what is the yield to maturity?
The bond鈥檚 yield to maturity is determined as the 9.73%
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Mel Thomas, the chief financial officer of Preston 91影视, has been asked to do an evaluation of Dunning Chemical Company by the president and chair of the board, Sarah Reynolds. Preston 91影视 was planning a joint venture with Dunning (which was privately traded), and Sarah and Mel needed a better feel for what Dunning鈥檚 stock was worth because they might be interested in buying the firm in the future.
Dunning Chemical paid a dividend at the end of year one of \(1.30, the anticipated growth rate was 10 percent, and the required rate of return was 14 percent.
a. What is the value of the stock based on the dividend valuation model (Formula 10-8)?
b. Indicate that the value you computed in part a is correct by showing the value of D1, D2, and D3 and by discounting each back to the present at 14 percent. D1 is \)1.30, and it increases by 10 percent (g) each year. Also discount the anticipated stock price at the end of year three back to the present and add it to the present value of the three dividend payments.
The value of the stock at the end of year three is: P3 5 D4 _____ Ke 2 g D4 5 D3 (1 1 g)
If you have done all these steps correctly, you should get an answer approximately equal to the answer in part a.
c. As an alternative measure, you also examine the value of the firm based on the price-earnings (P/E) ratio times earnings per share. Since the company is privately traded (not in the public stock market), you will get your anticipated P/E ratio by taking the average value of five publiclytraded chemical companies. The P/E ratios were as follows during the time period under analysis:
P/E Ratio
Dow Chemical .................. 15
DuPont ............................. 18
Georgia Gulf ..................... 7
3M .................................... 19
Olin Corp .......................... 21
Assume Dunning Chemical has earnings per share of \(2.10. What is the stock value based on the P/E ratio approach? Multiply the average P/E ratio you computed times earnings per share. How does this value compare to the dividend valuation model values that you computed in parts a and b?
d. If in computing the industry average P/E, you decide to weight Olin Corp. by 40 percent and the other four firms by 15 percent, what would be the new weighted average industry P/E? (Note: You decided to weight Olin Corp. more heavily because it is similar to Dunning Chemical.) What will the new stock price be? Earnings per share will stay at \)2.10.
e. By what percent will the stock price change as a result of using the weighted average industry P/E ratio in part d as opposed to that in part c?
Assume a firm has earnings before depreciation and taxes of \(200,000 and no depreciation. It is in a 40 percent tax bracket.
a. Compute its cash flow.
b. Assume it has \)200,000 in depreciation. Recompute its cash flow.
c. How large a cash flow benefit did the depreciation provide?
You invest \(3,000 for three years at 12 percent.Combine these steps using the formula FV 5 PV 3 (1 1 i) n to find the future value of \)3,000 in 3 years at 12 percent interest.
Rita Gonzales won the \(41 million lottery. She is to receive \)1.5 million a year for the next 19 years plus an additional lump sum payment of $12.5 million after 19 years. The discount rate is 14 percent. What is the current value of her winnings?
With inflation, what are the implications of using LIFO and FIFO inventory methods? How do they affect the cost of goods sold?
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