Tutorial 4: Stocks and Their Valuation

1. Constant growth valuation Thomas Brothers is expected to pay a $0.50 per share dividend at
the end of the year (that is, D1 = $0.50). The dividend is expected to grow at a constant rate of 7
percent a year. The required rate of return on the stock, r s, is 15 percent. What is the stock’s
value per share?

2. Nonconstant growth valuation Hart Enterprise recently paid a dividend,D 0, of $1.25. It

expects to have nonconstant growth of 20 percent for 2 years followed by a constant rate of 5
percent thereafter. The firm’s required return is 10 percent.

a) How far away is the terminal, or horizon, date?

b) What is the firm’s horizon, or terminal, value?
c) What is the firm’s intrinsic value today, ^
P0?

3. Preferred stock valuation Ezzell Corporation issued perpetual preferred stock with a 10
percent annual dividend. The stock currently yields 8 percent, and its par value is $100.

a) What is the stock’s value?

b) Suppose interest rates rise and pull the preferred stock’s yield up to 12 percent. What
would be its new market value?

4. Corporate valuation Dozier Corporation is a fast-growing supplier of office products.

Analyst project the following free cash flows (FCF s) during the next 3 years, after which FCF is
expected to grow at a constant 7 percent rate. Dozier’s WACC is 13 percent.

Year 0 1 2 3

FCF($millions) NA -$20 $30 $40

a) What is Dozier’s terminal, or horizon, value? (Hint: Find the value of all free cash flows
beyond Year 3 discounted back to Year 3)
b) What is the firm’s value today?
c) Suppose Dozier has $100 million of debt and 10 million shares of stock outstanding.
What is your estimate of the price per share?