CHAPTER EXERCISES

NAME SCORE:
SECTION: DATE:

PROBLEM SOLVING: Supply the answer for each requirement.

I. Dividend Discount Model Constant Growth: dividend per share (DPS), dividend
yield, capital gains yield and stock price computation:

SGV Inc.:
1. What is the expected dividend per share in year 1?
DIV1 = DIV0(1+g)1
DIV1 = 1.5(1+0.05)1
DIV1 = 1.575

2. What is the expected dividend per share in year 5?

DIV5 = DIV0(1+g)5
DIV5 = 1.5(1+.05)5
DIV5 = 1.9144

3. What is the price of the stock today (P0)?

div1
P0 =
rs-g
1.575
P0 =
0.12-0.05
P0 = 22.50

4. What is the price of the Stock after two years (P2)?

div3
P2 =
rs-g
1.575(1.05)2
P2 =
0.12-0.05
P2 = 24.81

OR
P2 = P0(1+.05)2
P2 = 22.5(1+.05)2
P2 = 24.81

5. What is the price of the stock after four years (P4)?

P4 = P2(1+.05)2
P4 = 24.81(1+.05)2

287
 P4 = 27.35

6. What is the expected dividend yield in year 1?

ETR = Dividend Yield + Capital Gains/(loss) yield
Div1
 DY =
Po

1.575
 DY = = 7%
22.5

7. What is the expected capital gains yield in year 1?

P1-P0
 CG(l)Y =
P0

23.625-22.5
 CG(l)Y =
22.5

 CG(l)Y = 5% - also equal to growth rate

Where:
P1 = P0(1+g)1
P1 = 22.5(1.05)1
P1 = 23.625

If in an investor of SGV Inc. stock sold his shares at P25 per share in year 1 after
receiving dividend:
8. What is the dividend yield?
ETR = Dividend Yield + Capital Gains/(loss) yield
Div1
 DY =
Po

1.575
 DY = = 7%
22.5

9. What is the capital gains yield?

P1-P0
 CG(l)Y =
P0

288
 25-22.5
 CG(l)Y =
22.5

 CG(l)Y = 11.11%

Where; P1 is the new selling price.

10. What is his total return from investment?

ETR = Dividend Yield + Capital Gains/(loss) yield

ETR = 7% + 11.11%
ETR = 18.11%

II. Dividend Discount Model Declining Growth Stock: dividend per share (DPS) and
stock price computation:

AMV Inc.
1. What is the expected dividend per share in year 1?
DIV1 = 2.0
2. What is the expected dividend per share in year 3?

DIV3 = DIV1(1+g)2
DIV3 = 2.0(1- 0.05)2
DIV3 = 2.0(0.95)2
DIV3 = 1.805

3. What is the price of the stock today (P0)?

div1
P0 =
rs-g
2.0
P0 =
0.08-(-0.05)
P0 = 15.38

4. What is the price of the Stock after two years (P2)?

div3
P2 =
rs-g
1.805
P0 =
0.08-(-0.05)
P0 = 13.88

5. What is the price of the stock after four years (P4)?

P4 = P0(1+g)4

289
 P4 = 15.38(0.95)4
P4 = 12.53

III. Dividend Discount Model Non-Constant Growth Stock: dividend per share (DPS)
and stock price computation:

SBC Management Corp

1. What is the expected dividend per share in year 3?

DIV1 = DIV0(1+g)1
DIV1 = 1.0(1.20)1 = 1.20

DIV2 = DIV1(1+g)1
DIV2 = 1.2(1.20)1 = 1.44
TERMINAL DATE ____________________________
DIV3 = DIV2(1+g)1
DIV3 = 1.44(1.05)1 = 1.512

div3
 TV2 =
rs-g
1.512
 TV2 =
0.12-0.05
 TV2 = 21.60
2. What is the terminal value? 21.60
3. What is the price of the stock today (P0)?
P0 =
[1.20
1+
1.44
(1.12) (1.12) 2 +
] [
21.60
(1.12)2
= 19.44
]
4. What is the price of the Stock after one year (P1)?
P1 = 0+
[ 1.44
(1.12) ] [
1 +
21.60
(1.12)1 ]
= 20.57

5. What is the price of the stock after three years (P3)?

P2 = [0+0] + [
21.60
(1.12)0 ]
= 21.60

After the terminal date, the constant phase begins, hence, the shortcut format
will now be applicable.

P3 = P0(1+g)1
P3 = 21.60(1.05)1
P3 = 22.68

290
IV. Dividend Discount Model Non-Constant Growth Stock: required rate of return
(r),dividend per share (DPS) and stock price computation:

The Insecurity Bank (IB)

1. What is the cost of equity (Ke) or required rate of return?

Using CAPM,Rs = Rfr + (Mrp)β
Rs = 3% + (6%)1.5
Rs = 12%

2. What is the amount of Div1; Div2; Div3; Div4?

DIV1 = DIV0(1+g)1
DIV1 = 1.0(1.05)1 = 1.05

DIV2 = DIV1(1+g)1
DIV2 = 1.05(1.05)1 = 1.1025
TERMINAL DATE ____________________________
DIV3 = DIV2(1+g)1
DIV3 = 1.1025(1.10)1 = 1.21275

DIV4 = DIV2(1+g)2
DIV4 = 1.1025(1.10)2 = 1.334025

3. What is the terminal value (TV2)?

div3
 TV2 =
rs-g
1.21275
 TV2 =
0.12-0.10
TV2 = 60.6375

4. What is IB’s common stock price today (P0)?

P0 =
[ 1.05 1.1025
1+
(1.12) (1.12) 2 +
] [
60.6375
(1.12)2 ]
= 50.15625

5. What is the price of the stock after 1 year (P1), 2 years (P2), three years (P3) and 4 years
(P4)?

P1 = 0+[ 1.1025
(1.12)1
+ ] [
60.6375
(1.12)1 ]
= 55.14

P2 = [0+ 0] +
[ 60.6375
]
(1.12)0
= 60.6375

291
 P3 = P2(1+g)1
P3 = 60.6375(1.10)1
P3 = 66.70125

P4 = P3(1+g)1
P3 = 66.70125(1.10)1
P3 = 73.37

V. Corporate Valuation Model Constant Growth: Free Cash Flow (FCF), Weighted
Average Cost of Capital (WACC), Market Value and Stock Price computation:

Bank of Mama Corporation (BMC)

1. What is the expected free cash flow this year?
FCF1 = [NOPAT + Depr + Amort. - Capex - Increase in WC]
FCF1 = [ EBIT (1 - TR) + Depr + Amort. - Capex - Inc. in WC]
FCF1 = [ 900M (1-0.4)+120M+30M -300M-180M]
FCF1 = 210Million
 It is FCF 1 because of the terms projected or expected.

2. What is the expected free cash flow next year(year 2)?

FCF1 = FCF0 (1+g)1
FCF2 = FCF1 (1+g)1
FCF2 = 210M(1+0.05)1 = 220.5Million

3. What is the weighted average cost of capital (WACC)?

WACC = [Kd (1-tr)DR] + [ Ke (ER)]
WACC = [11.66% (1-0.4)40%] + [ 15.336% (60%)]
WACC = 12%

4. What is the market value of BMC this year?

FCF1
MV Firm (asset) =
Wacc-g
210 Milllion
MV Firm (asset) = = 3, 000,000,000
0.12-0.05

5. What is the intrinsic value (stock price) of BMC stock?

MV Firm (asset) =3,000,000,000
MV (Debt and Preferred) = (1,000,000,000)
MV Common Stocks 2,000,000,000

292
 ÷
WANOSO (shares OS) 5,000,000 shares
Intrinsic Value (Po) = P 400 per share

VI. Corporate Valuation Model Non-Constant Growth: Free Cash Flow (FCF),
Weighted Average Cost of Capital (WACC) Market Value and Stock Price
computation:

COA Corporation.

1. What is the amount of free cash flow this year (FCF1), second year (FCF2), third year
(FCF3), fourth year (FCF4)?

FCF1 = 500,000
FCF2 = FCF1(1+g)1
FCF2 = 500,000(1.20)1 = 600,000

FCF3 = FCF2(1+g)1
FCF3 = 600,000(1.20)1 = 720,000

TERMINAL DATE ____________________________

FCF4 = FCF3(1+g)1
FCF4 = 720,000(1.06)1 = 763,200

2. How much is the weighted average cost of capital (WACC)?

WACC = [Kd (1-tr)DR] + [ Ke (ER)]

WACC = [8.88% (1-0.4)30%] + [ 12% (70%)]
WACC = 9.998% or 10%

3. How much is the Firm’s Terminal Value?

FCF3
TV2 =
wacc-g

763,200
TV2 =
0.10-0.06

293
 TV2 = 19,080,000

4. How much is the Market Value of the Firm?

MV Firm =
[ 500,000 600,000 720,000
(1.10) 1 +
(1.10) 2 +
] [
(1.10) 3 +
19,080,000
(1.10)3 ]= 15,826,446

5. How much is the Intrinsic Value of the Stock?

MV Firm (asset) = 15,826,446,

MV (Debt ) = (3,326,446)
MV Equity = 12,500,000
MV Preferred 5,000,000
MV Common Stocks 7,500,000
÷
WANOSO (shares OS) 250,000 shares
Intrinsic Value (Po) = P 30 per share

TRUE or FALSE: Write X if the statement is true while M if false.

1. X

2. M (Preferred stocks)
3. X

4. M (Non-participating shares)
5. X
6. M (company’s free cash flows.)
7. X
8. M (weighted average cost of capital.)
9. M (overvalued.)

294
 10. M (is lower )
11. M (future value of the expected free cash flow at the end of that horizon.)

12. M (readily be observed.)

13. X
14. X
15. M (“sell” order)
16. X
17. X
18. M (dividing the expected free cash flow )
19. X
20. X

MULTIPLE CHOICE QUESTIONS: Choose the letter of the best answer.

THEORIES

1. Which of the following situations depict an equilibrium:

i. Market Value of a stock equals its Intrinsic Value
ii. The Expected Return of a stock equals its Required Return
iii. The stock’s Growth Rate equals its Required Return
iv. The yearly dividends shall be the same indefinitely.
A. Statements i and ii
B. Statements i, ii and iii
C. Statements i and iv
D. None of the above

2. The change in growth rate is a factor of

A. market or economic conditions
B. company-specific or firm
C. both market and company-specific
D. the stock’s Beta

3. In an equilibrium condition and during a constant growth phase, the stock’s growth
rate should equal the
A. dividend yield
B. capital gains yield
C. required return
D. corrected closing stock price

4. The process of estimating the intrinsic value of a preferred stock generally shows an
example of
A. an indefinitely increasing stock
B. a perpetuity
C. zero-growth stock

295
 D. both B and C

5. The weighted-average cost of capital or (WACC) serves as the equivalent of the cost
of equity or required return in the corporate valuation model. Which of the following is
not an element of WACC?
A. Cost of common equity
B. Cost of preferred equity
C. Cost of debt
D. Tax-adjusted cost of debt

6. The terminal value of a non-constant growth stock should be discounted using which
of the following periods?
A. The last period (year) of the constant growth phase.
B. The first period (year) of the non-constant growth phase.
C. The midpoint period (year) of the non-constant growth phase.
D. The last period (year) of the non-constant growth phase.

7. Which of the following is not a common stockholder’s legal right and privileges?
A. Right to elect the corporation’s directors
B. Subordinate to preferred shareholders in terms of dividend distribution
C. Right to be elected as a director of the corporation
D. Right to first receive the dividends before all other shareholders receive their
share

8. The considerations associated with stock valuation do not include:

A. the expected future dividend performance of the stock
B. the estimated selling time and price of the stock
C. the exchange on which the stock is traded
D. the market return on stocks of that type

9. The market value of common stock is primarily based on

A. the firm's future earnings.
B. book value.
C. total assets.
D. retained earnings.

10. In the constant-growth model, the market return must be ____ the dividend growth
rate in order for the formula price to be meaningful.
A. less than
B. equal to
C. greater than
D. proportional to

11. The analysis of estimating a stock’s intrinsic value is assumed to be performed by

the

296
 A. Optimistic Investor
B. Perfect Investor
C. Pessimistic Investor
D. Marginal Investor

12. A negative growth rate is also referred to as

A. Declining growth
B. Upstream growth
C. Supernormal growth
D. Zero growth

13. Complete the sentence: The marginal investor is an investor who is at the margin
and would be willing to _____ if the stock price was slightly lower or to sell if the price
was slightly _____.
A. sell; lower
B. hold; higher
C. buy; higher
D. buy; lower

14. The considerations associated with stock valuation do not include:

A. the expected future dividend performance of the stock
B. the estimated selling time and price of the stock
C. the exchange on which the stock is traded
D. the market return on stocks of that type

15. You are considering investing in ABC, Inc.'s stock which is selling at P45.95. Similar
stocks return 16%. ABC's last dividend ABC was P4.50 and a 6% constant growth
rate is anticipated. Should you purchase ABC, Inc.?
A. No, because the stock is overpriced by P1.75
B. No, because the stock is overpriced by P3.85
C. Yes, because the stock is underpriced by P1.75
D. Yes, because the stock is underpriced by P3.85

PROBLEMS: (use at least five decimal places for present value computation)

A. Petro-Max Corporation’s
1. What is the amount of expected dividend today?
A. 0.70
B. 0.75
C. 0.80
D. 1.75

2. What is the stock’s expected dividend yield today?

A. 2.8%
B. 3.0%

297
 C. 3.2%
D. 7.0%

3. What is the expected stock price the next year?

A. 26.75
B. 27.50
C. 28.63
D. 30.00

4. What is the expected stock price four years from today?

A. 28.14
B. 30.63
C.32.77
D.36.60

B. During the past few years, Metro De Oro (MDO) Bank has retained, on an
5. What is the market risk premium using CAPM?
A. 4%
B. 8%
C. 12%
D. 16%
6. What is the required rate of return using CAPM?
A.4%
B. 8%
C.12%
D.16%

7. What is the company’s current market price?

A. 25
B. 27.5
C.30.25
D. 32

8. What is the expected dividend yield?

A. 4.50%
B. 4.95%
C.5.45%
D. 6.00%

9. What is the expected earnings per share (EPS)?

A. 5.0 : 1
B. 5.5: 1
C.6.0 : 1
D. 6.5: 1

10. What is the expected price earnings ratio (PER)?

298
 A. 5
B. 5.7
C.6
D. 6.5

C. GLOBAL Technology’s
11. What is the GLOBAL Technology’s Beta?
A. 1.0
B. 1.06
C. 1.25
D. 2.0

12. What is the expected dividend yield?

A. 4.67%
B. 5%
C.5.35%
D. 7.0%

13. Determine the capital gains yield?

A. 6%
B. 6.65%
C. 7%
D. 7.33%

14. What is the expected stock price three years from today?
A. P42.8
B. P45.80
C. P 49
D. 52.43

D. UNION LAND Corporation’s financial information stated the following:

15. What is the Earnings per share?

A. P1 per share
B. P 3 per share
C. P 4 per share
D. P 5 per share

16. What is the market price per share?

A. P5
B. P 15
C.P 20
D.P 25

17. What is the dividend yield?

A. 21%

299
 B. 20%
C.16%
D. 10%
18. What is the Plow back Ratio or retention ratio?
A. 5%
B. 10%
C.15%
D. 20%

19. What is the expected growth rate?

A. 5%
B. 10%
C.15%
D.20%

20. What is the expected rate of return?

A. 21%
B. 20%
C.16%
D. 10%

E. Fil-Ham Life
21. What is the terminal value?
A. P 156.25
B. P 171.875
C. P 173.43
D. P 214.84

22. What is the present value of the cash flows under the supernormal phase?
A. P 2.394
B. P 3.391
C.P 139.49
D. P 174.36

23. What is the present value of the cash flows under the constant phase?
A. P 2.394
B. P 3.394
C.P 139.49
D. P 174.36

24. What is the stock price of Fil-Ham life today?

A. P 141.88.

300
 B. P 142.88
C. P 175.88
D. P 176.88

25. What is the stock price of Fil-Ham life after one year?
A. 154.84
B. 156.25
C. 177.35
D. 178.60

26. What is the stock price of Fil-Ham life after two years?
A. 156.25
B. 157.81
C.171.88
D.173.44

27. What is the stock price of Fil-Ham life after three years?
A. 171.87
B. 189.07
C.190.78
D. 192.52

F. RAT Kim Eng.

28. What is the market value of RAT Kim Eng using the corporate valuation model?
A. P 625 Million
B. P 662. 5 Million
C. P 825 Million
D.P 855 Million

29. What is the estimated per-share price of RAT Kim Eng’s common stock today?
A. 14.17
B. 17.00
C. 20.80
D. 26.20

G. Phil-Mining Corporation
30. What is the Expected free cash flow of the firm (FCF1)?
A. P 400 Million
B. P 380 Million
C. P140 Million
D. P 20 Million

31. What is the weighted average cost of capital (WACC)?

A. 9.876%
B. 9.998%

301
 C.12%
D.13.73%

32. What is the market value of the company?

A.P 1.5 Billion
B. P 3.0 Billion
C. P 3.5 Billion
D. P 9.5 Billion

33. From the preceding number, if the market value of debt and preferred stock is P1
billion and the stock price is P62.50 per share, what is the number of outstanding
shares?
A. 31,350,000 shares
B. 32,000,000 shares
C. 40,000,000 shares
D.136,000,000 shares

H. Petcorn Corporation. The analyst determined that Petcorn’s free cash flow

34. What is the market value of Petcorn Corporation using the corporate valuation
model?
A. P 925,018,782.95
B. P 982,043,576.25
C. P 1,012,043,576.25
D. P 1, 110,043.576.25

35. What is the estimated per-share price of Petcorn’s common stock today?
A. P 15.50
B. P 36.25
C. P 39.10
D. P 40.60

36. What is the estimated per-share price of Petcorn’s common stock after 2 years?
A. P 40.73
B. P 41.45
C. P 43.93
D. P 45.96

I. North East Bank Corporation (NEBC)

37. What is the required rate of return on equity?

A. 4.5%
B. 5.5%
C. 10%
D. 13.75%

302
38. By how much will the stock price under dividend discount model be higher /
(lower) than stock price under corporate valuation model?
A. P 9.50 higher
B. P 19.96 higher
C. P (P9.50) lower
D. P (19.96) lower

“THAT IN ALL THINGS, GOD MAY BE GLORIFIED”

“Nothing is permanent in this world, except change”

303