MODULE 3 ACTIVITY FINANCIAL MANAGEMENT MBA 2

ACTIVITY 2: STOCK VALUATION

I. Common Stock Value- Constant Growth
         Mckapoy Corporation, common stock paid a dividend of P12.50 per share last year. The
company expects earnings and dividends to grow at 6% per year for the foreseeable future
year
a. What is the value of the stock if the required rate of return is 12.5% per year?
Formula: Value of Stock = ________Dividend of Share_________
Rate of Return – Growth Rate
Given: Dividend of Share: P12.50
Rate of Return: 12.5% or 0.125
Growth Rate: 6% or 0.06

Value of Stock = ____P12.50____

0.125 – 0.06

Value of Stock = P 192.31

b. What is the required rate of return for this stock would result in a price per share of
P250?
Formula: Value of Stock = ________Dividend of Share_________
Rate of Return – Growth Rate

Rate of Return = __Dividend of Share__ + Growth Rate

Value of Stock

Given: Dividend of Share: P12.50

Value of Stock: P250
Growth Rate: 6% or 0.06

Rate of Return = __P12.50__ + 0.06

P250

Rate of Return = 0.05 + 0.06

= 0.11 or 11%

II. Common Stock Value- All growth models 

       You are evaluating the potential purchase of a small business currently giving out
dividend per share of P4.25. On the basis of a review of similar-risk investment opportunities,
you must earn an 18% rate of return on the proposed purchase. Because you are relatively
uncertain about future cash flows, you decide to estimate the firm’s value using several
possible assumptions about the growth rate of cash flows: 
a. What is the firm’s value of stock if expected to grow at an annual rate of 0% from now
to infinity? 
Formula: Value of Stock = ________Dividend of Share_________
Rate of Return – Growth Rate
Given: Dividend of Share: P 4.25
Rate of Return: 18% or 0.18
Growth Rate: 0% or 0.00

Value of Stock = ____P4.25____

0.18 – 0.00
Value of Stock = P 23.61
b. What is the firm’s value of stock if dividends are expected to grow at a constant rate
of 8% from now to infinity?
Formula: Value of Stock = ________Dividend of Share_________
Rate of Return – Growth Rate
Given: Dividend of Share: P 4.25
Rate of Return: 18% or 0.18
Growth Rate: 8% or 0.08

Value of Stock = ____P4.35____

0.18 – 0.08
Value of Stock = P 42.50
c. What is the firm’s value of stock if dividends are expected to grow at an annual rate of
15% for the first 3 years, 12% for the next 2 years and followed by a constant annual
rate of 8% from 6 years to infinity? 
  Value of stock dividends for the first three years, growing at 15% annually:
Year 1 dividend: P4.25 * (1 + 0.15) = P4.89
Year 2 dividend: P4.89 * (1 + 0.15) = P5.62
Year 3 dividend: P5.62 * (1 + 0.15) = P6.46
 Value of stock dividends for the next two years, growing at 12% annually:
Year 4 dividend: P6.46 * (1 + 0.12) = P7.25
Year 5 dividend: P7.25 * (1 + 0.12) = P8.12
Value of stock dividends from year 6 to infinity, growing at a constant rate of 8%
annually:
Year 6 dividend: P8.12 * (1 + 0.08) = P8.78
Year 7 dividend: P8.78 * (1 + 0.08) = P9.49
Value of stocks in infinite series of dividends:
P8.78 / (0.18 - 0.08) + P9.49 / (0.18 - 0.08) + P9.49 / (0.18 - 0.08)2 + ...
Value of dividend payments using the Gordon Growth Model:
Value of Stock = (P4.89 / (1 + 0.18)) + (P5.62 / (1 + 0.18)2) + (P6.46 / (1 + 0.18)3)
+ (P7.25 / (1 + 0.18)4) + (P8.12 / (1 + 0.18)5) + (P8.78 / (0.18 - 0.08)) + (P9.49 /
(0.18 - 0.08)) + (P9.49 / (0.18 - 0.08)2) + ...

III. Free Cash Flow Valuation

Humtha Industries is considering going public but is unsure of a fair offering price for
the company. The firm’s CFO has gathered data for performing the valuation using the free
cash flow valuation model. The firm’s weighted average cost of capital is 11% and it has P1.5
million of debt at market value and P500,000 of preferred stock at its assumed market value.
The estimated free cash flows over the next 5 years 2016 through 2020 are given below.
Beyond 2020 to infinity, the firm expects its free cash flow to grow by 3% annually. 

2016 - P 250,000 2019 - P 450,000

2017 -    320,000 2020 -     480,000

2018 -    400,000

Required: 
Using the free cash flow valuation method, estimate the value of Humtha Industries’ entire
company, the total value of Common Stock and the estimated value per share assuming the
firm plants to issue 250,000 shares of common stock.

Given:
 Year FCFt Other Data
2016 P 250,000 Growth Rate of FCFt, beyond 2020 to infinity: 3% or 0.03
2017 P 320,000 WACC: 11% or 0.11
2018 P 400,000 Market Value of Debt: P 1.5 Million
2019 P 450,000 Market Value of Preferred Stock: P 500,000
2020 P 480,000 No. of Shares of Common Stock: 250,000

Answer:
Present value of free cash flow occurring from the end of 2021 to infinity, measured at
the end of 2020:
Value of FCF2020 → ∞ = __FCF2021__
ra – gFCF
= __P 480,000 ( 1 + 0.03 )__
0.11 – 0.03
= __P 494,400__
0.08
= P 6,180,000
Total FCF of 2020:
Total FCF2020 = 2020 FCF + Value of FCF from 2021 to infinity
= P 480,000 + P 6,180,000
= P 6,660,000

Value of Entire Company: Sum of Present Values of FCFs for 2016 through 2020, VC:
VC = ____FCFt_____ + ____FCFt_____ + ...
(1+WACC) (1+WACC)2
VC = P 250,000 + P 320,000 + P 400,000 + P 450,000 + P 480,000
(1.11) (1.11)2 (1.11)3 (1.11)4 (1.11)5
= P 225,225 + P 259,719 + P 292,477 + P 296,429 + P 284,857
= P 1,358,707

Value of Common Stock:

 Vs = VC + VD + VP

Where: VC = Value of Entire Company

VD = Market Value of Debt
VP = Market Value of Preferred Stock

Vs = P 1,358,707 + P 1,500,000 + P 500,000

= P 3,358,707
Estimate Value per Share:
Price = Vs ÷ No. of Shares
= P 3,358,707 ÷ 250,000
= P 13.43