Stefven Putra

B1024181036

EXERCISES ON STOCK VALUATION MODEL

1) Define the following terms:

a. Proxy; proxy fight; takeover
- Proxy is a document giving one person the authority to act for another, typically
the power to vote shares of common stock; management always solicits proxy
and usually receives them.
- Proxy fight is an attempt by a person or group to gain control of a firm by getting
its stockholders to grant that person or group the authority to vote its shares to
replace the management; often happens if earnings are poor and stockholders
are dissatisfied.
- Take over is an action whereby a person or group succeeds in ousting a firm's
management and taking control of the company; frequency of these fights has
increased as have attempts by one corporation to take over another by
purchasing much of the outstanding stock.

b. Preemptive right
A provision in the corporate charter or bylaws that gives common stockholders
the right to purchase on a pro rata basis new issues of common stock (or
convertible securities):
(1) prevents the management of a corporation from issuing a large number of
additional shares and purchasing those shares itself which they would use to take
control of the company.
(2) protects stockholders from a dilution of value.

c. Classified stock; founders’ shares

- Classified stock is common stock that is given a special designation such as Class
A or Class B to meet special needs of the company; the use of classified stock
often enables the company's founders to maintain control over the company
without having to own a majority of the common stock.
- founders’ shares is class B stock is often called this; stock owned by the firm's
founders that enables them to maintain control over the company without having
to own a majority of stock.

d. Marginal investor; intrinsic value (P0); market price (Pm)

- Marginal investor is a representative investor whose actions reflect the beliefs of
those people who are currently trading stock. It is the marginal investor who
determines a stock's price.
- Intrinsic value represents the "true" value of the company's stock; When
investing in common stock, the goal is to purchase stocks that are undervalued
(price under intrinsic value) and avoid stocks that are overvalued. Two models
are used to determine intrinsic value: Discounted Dividend Model, and Corporate
Valuation Model.
- Market price is the price at which a stock sells in the market.
 e. Required rate of return, rs; expected rate of return, rs; actual (realized) rate of
return, rs
- Required rate of return is the minimum rate of return on a common stock that a
stockholder considers acceptable; rate of return on the stock considering its
riskiness and the returns available on other investments.
- Expected return is the rate of return on a common stock that a stockholder
expects to receive in the future; can be above or below required return; rational
investor will BUY if expected is EXCEEDED required and sell vice versa.
- Actual (realized) rate of return is the rate of return on a common stock actually
received by stockholders in some past period; may be greater or less than
expected and/or required.

f. Capital gains yield; dividend yield; expected total return; growth rate (g)
- Capital gain is the capital gain during a given year divided by the beginning price.
- Dividend yield is the expected dividend divided by the current price of a share of
stock
- Expected total return is the sum of the expected dividend yield and the expected
capital gains yield.
- Growth rate is the expected rate of growth in dividends per share.

g. Zero growth stock

- A common stock whose future dividends are not expected to grow at all; g = 0

h. Constant growth (Gordon) model; supernormal (nonconstant) growth

- Constant growth is reasonable to predict that dividends will grow at a constant
rate; P hat sub 0 = D sub1 divided by r sub s (required rate of return) - g (growth
rate).
- Supernormal growth is the part of the firm's life cycle in which it grows much
faster than the economy as a whole.

i. Corporate valuation model

- A valuation model used as an alternative to the discounted dividend model to
determine a firm's value, especially one with no history of dividends, or the value
of a division of a larger firm. The corporate model first calculates the firm's
future free cash flows, then finds their present values to determine the firm's
values.

j. Horizon (terminal) date; horizon (continuing) value

- Horizon (terminal) date is the date when the growth becomes constant; it is no
longer necessary to forecast the individual dividends.
- Horizon (continuing) value is the value at the horizon date of all dividends
expected thereafter; First, assume that the dividend will grow at a nonconstant
rate for N periods, after which it will grow at a constant rate, g; N is often called
the horizon, or terminal date; Second, we can use the constant growth formula to
determine what the stock's horizon, or continuing value will be N periods from
today.
 k. Preferred stock
- Unlike bonds, preferred has a par value and a fixed dividend that must be paid
before dividends can be paid on common stock; however, the directors can omit
the preferred dividend without throwing the company into bankruptcy. Entitles
its owners to regular, fixed dividend payments.

2) Is the following equation correct for finding the value of a constant growth stock?

Explain.

The formula listed is incorrect.

The correct formula is:

𝐷1
𝑃0 = 𝑟𝑠 + 𝑔
Where:
P0 = Price/Value of stock today
D1 = Expected value of dividends after 1 year
r = required rate of return
g = growth rate
This is also known as the Gordon Growth Model

3) Discuss the similarities and differences between the discounted dividend and
corporate valuation model

- Similarities between discounted dividend and corporate valuation model

1. The cash flows are discounted at a specified rate.
2. Expected future cash flows are used to value the stock.
3. The cash flows start 1 year/period from now, and are assumed to
continue to be generated at equal intervals of time indefinitely.
4. The cash flows are assumed to grow at a constant rate smaller than the
discount rate.
- Differences between discounted dividend and corporate valuation model
1. The cash flows used are dividends for the dividend discount model and
free cash flow to the firm for the corporate valuation model
2. The discount rate used are the required return for the dividend discount
model and weighted average cost of capital for the corporate valuation
model

4) DPS CALCULATION Willy Brod Corporation just paid a dividend of $1.00 a share
(i.e., D0 = $1.00). The dividend is expected to grow 12% a year for the next 3
years and then at 5% a year thereafter. What is the expected dividend per share
for each of the next 5 years?

Formula : Expected Dividend = Paid dividend x (1 + g)

 D1 = $1.00 x (1,12) = $1,12
D2 = $1,12 x (1,12) = $1,25
D3 = $1,25 x (1,12) = $1,4
D4 = $1,4 x (1,05) = $1,47
D5 = $1,47 x (1,05) = $1,54

5) CONSTANT GROWTH VALUATION Tresna Brothers is expected to pay a $1.80 per

share dividend at the end of the year (i.e., D1 = $1.80). The dividend is expected
to grow at a constant rate of 4% a year. The required rate of return on the stock
(rs) , is 10%. What is the stock’s current value per share?
D1= $1.80
g= 4% (0.04)
r= 10% (0.10)

P = D1/(r-g)
P = 1.80 / (0.10 - 0.04)
P = $30

6) CONSTANT GROWTH VALUATION Purnama Agung’s stock currently sells for

$38.00 a share. It just paid a dividend of $2.00 a share (i.e., D0 = $2.00). The
dividend is expected to grow at a constant rate of 5% a year. What stock price is
expected 1 year from now? What is the required rate of return?
D0 = $2.00
P0 = $38.00
g = 5% (0.05)
r=?
P1 = ?
D1 = D0(1+g)
D1 = 2 (1+0.05)
D1 = $2.1

D2 = 2.1 (1+0.05)
D2 = $2.21

P0 =D1/(r-g)

r = (D1/P0)+g

r = ($2,1/$38) +0,05

r = 11%

P1 = D2/(r-g)
P1 = 2.21/ (0.11 - 0.05)
P1 = $37
7) NONCONSTANT GROWTH VALUATION Holding Enterprises recently paid a
dividend, D0 , of $2.75. It expects to have nonconstant growth of 18% for 2 years
followed by a constant rate of 6% thereafter (supernormal growth). The firm’s
required return is 12%.
a. How far away is the horizon date?
The date at which the growth rate becomes constant is the horizon date. In this
case, the growth rate is non constant for the first 2years, which then becomes
constant at a rate of 2 years. Thus, the horizon date is 2 years away.
b. What is the firm’s horizon, or continuing, value?
Given:
Dividend (D0) = $2.75
Nonconstant growth rate = 18%
Constant growth rate (g) = 6%
Required rate of return (r) = 12%

Required: Horizon value (P2)

Formula:
P2 = D2 (1+g)/r-g
D2 = D1 x (1+g)
= (D0) (1+g) x (1+g)
= ($2.75) (1.18) x (1.18)
= $3.8291

P2 = D2 (1+g)/r-g
= $3.8291 (1+6%)/(12%-6%)
= $3.8291 (1.06)/0.06
= $67.65

c. What is the firm’s intrinsic value today, P

The price of the stock today is equal to the sum of the present value of the
dividends for years 1 and 2, plus the present value of the horizon value of $67.65.
Formula
𝐷1 𝐷2 𝑃2
𝑃0 = 1+𝑟
+ 2 + 2
(1 + 𝑟) (1 + 𝑟)

$3.245 $3.8291 $67.65

= 1 + 12%
+ 2 + 2
(1 + 12%) (1 + 12%)

$3.245 $3.8291 $67.65

= 1.12
+ 2 + 2
(1.12) (1 .12)

$3.245 $3.8291 $67.65

= 1.12
+ 1.2544
+ 1.2544
 = $2.89732 + $3.05253 + $53.93
= $59.88
8) CORPORATE VALUATION Sempurna Technologies is expected to generate $25
million in free cash flow next year, and FCF is expected to grow at a constant rate
of 4% per year indefinitely. Sempurna has no debt or preferred stock, and its
WACC is 10%. If Sempurna has 40 million shares of stock outstanding, what is the
stock’s value per share?

Given:
Free Cash Flow (FCF) = $25,000,000
Constant growth rate (g) = 4%
Weighted average cost of capital (WACC) = 10%

Required: Stock Value Per Share?

Formula:
Market value of company = FCF/(WACC - g)
= $25,000,000/(0.10 - 0.04)
= $416,666,666.67

Stock value per share = Market value of company/number of shares outstanding

= $416,666,666.67/40,000,000
= $10.42

9) PREFERRED STOCK VALUATION Farley Inc. has perpetual preferred stock

outstanding that sells for $30 a share and pays a dividend of $2.75 at the end of
each year. What is the required rate of return?

Given:
Preferred share price (Vp) = $30
Dividend per share (DPS) = $2.75

Required: Required rate of return (r)

Formula:
Vp = DPS/r
$30 = $2.75/r
r = $2.75/$30
r = 9.17%