AFM291 Lecture Notes - Lecture 7: Valuation Using Multiples, Dividend Discount Model, Net Present Value
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Bremond Equipment Supply Corporation (BESC) needs to determine its Weighted Average Cost of Capital in order to make a few capital budgeting decisions. The firm has already established the proporation of its capital. Use these proportions in calculating the firm's WAAC.
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| Target Market |
| Source of Capital | Proportions |
| Long-term debt | 69% |
| Preferred stock | 5% |
| Common stock equity | 26% |
Debt: BESC can sell a 15-year, semi-annual,$1,000 par value, 8.75 percent bond for $985. A flotation cost of 1.75 percent of the face value would be required in addition to the discount of $15.
Preferred Stock: BESC has determined it can issue preferred stock at $70 per share par value. The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is $2 per share.
Common Stock: BESC's common stock is currently selling for $42 per share. The dividend expected to be paid at the end of the coming year is $5.35 Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.00. It is expected that to sell, a new common stock issue must be underpriced at $4 per share and the firm must pay $1 per share in flotation costs.
Additionally, the firm's marginal tax rate is 40 percent.
To help determine the firm’s WACC, we will break this problem down into steps:
Calculate the rate for the new bond issue, notice is has semi-annual compounding.
Calculate the after-tax cost of the bond issue.
Calculate the cost of the new issue of preferred stock.
Calculate the growth rate of the common stock dividends.
Calculate the cost of the new common stock issue.
Finally, calculate the firm's weighted average cost of capital assuming the firm has exhausted all retained earnings.
| Constant Growth Stock Valuation You are analyzing Jillian’s Jewelry (JJ) stock for a possible purchase. JJ just paid a dividend of $1.50 yesterday. You expect the dividend to grow at the rate of 4% per year for the next 3 years, if you buy the stock; you plan to hold it for 3 years and then sell it. What dividends do you expect for JJ stock over the next 3 years? In other words, calculate D1, D2 and D3. Note that D0 = $1.50. Round your answers to the nearest cent.D1 = $ ________ D2 = $ ________ D3 = $ ________ JJ's stock has a required return of 11%, and so this is the rate you'll use to discount dividends. Find the present value of the dividend stream; that is, calculate the PV of D1, D2, and D3, and then sum these PVs. Round your answer to the nearest cent. JJ stock should trade for $25.07 3 years from now (i.e., you expect = $25.07). Discounted at a 11% rate, what is the present value of this expected future stock price? In other words, calculate the PV of $25.07. Round your answer to the nearest cent. If you plan to buy the stock, hold it for 3 years, and then sell it for $25.07, what is the most you should pay for it? Round your answer to the nearest cent. Use the constant growth model to calculate the present value of this stock. Assume that g = 4%, and it is constant. Round your answer to the nearest cent. Is the value of this stock dependent on how long you plan to hold it? In other words, if your planned holding period were 2 years or 5 years rather than 3 years, would this affect the value of the stock today, ? Explain your answer. |