Chapter 7 Problems
1. Preferred Dividends. In each case in the following table, how many dollars of
preferred dividends per share must be paid to preferred stockholders in the current
period before common stock dividends are paid?
Case Type Par Value Dividend per share
per period
Periods of dividends
passed
A Cumulative 100 $5 3
B Noncumulative 120 3% 2
C Noncumulative 100 $4 1
D Cumulative 80 1.5% 4
E Cumulative 60 3% 0
2. Preferred Stock Valuation. RSR Inc. has an outstanding preferred stock issue with a
par value of $75 per share. The preferred shares pay dividends annually at a rate of 10
percent.
a. What is the annual dividend on RSR preferred stock?
b. If investors require a return of 8% on this stock and the next dividend is
payable one year from now, what is the price of RSR preferred stock?
c. Suppose that RSR has not paid dividends on its preferred shares in the last 3
years, but investors believe that it will start paying dividends again in one
year. What is the value of RSR preferred stock if it is cumulative and if
investors require an 8 percent rate of return?
3. Common Stock Value: Constant Growth. ABC Company has paid dividends as
shown over the past 6 years:
Year Dividend per share
2018 2.68
2017 2.53
2016 2.38
2015 2.25
2014 2.12
2013 2.00
ABC’s 2019 dividend is expected to be $2.84.
1. If you can earn 14 percent on similar-risk investments, what is the most
you would be willing to pay per share?
2. If you can earn only 9 percent on similar-risk investments, what is the
most you would be willing to pay per share?
3. Compare and contrast your findings in parts a and b, and discuss the
impact of changing risk on share value.
4. Common Stock Value: Variable Growth. Hospitality Bakery’s most recent annual
dividend was $2.00 per share (D0 = 2.00), and the firms required rate of return is 12
percent. Find the market value of Hospitality Bakery’s shares when:
a. Dividends are expected to grow at 9 percent annually for 3 years, followed
by a 6 percent annual growth rate in years 4 on.
b. Dividends are expected to grow at 9 percent annually for 3 years, followed
by a zero percent annual growth rate in years 4 on.
c. Dividends are expected to grow at 9 percent annually for 3 years, follow
by a 10 percent annual growth rate in years 4 on.
5. Free Cash Flow Valuation. Longview Industries is considering going public, but
is unsure of a fair offering price for the company. Before hiring an investment
banker to assist in making the public offering, managers at LI have decided to
make their own estimate of the firm’s common stock value. The firm’s CFO has
gathered data for performing the valuation using the free cash flow valuation
model.
LI’s weighted average cost of capital is 12 percent, and it has $2,000,000 of debt
at market value and $500,000 of preferred stock at its assumed market value. The
estimated free cash flows over the next 5 years are given below. From year 5 on,
the firm expects its free cash flow to grow by 4 percent annually.
Year (t) Free Cash Flow (FCFt)
1 250,000
2 275,000
3 300,000
4 330,000
5 350,000
a) Estimate the value of LI (the entire company) by using the free cash frow
valuation model.
b) Use your findings in part a, along with the data provided above, to find LI’s
common stock value.
c) If LI plans to issue 250,000 shares of common stock, what is its estimated
value per share?
6. Valuation with Price/Earnings Multiples. For each of the firms below, use the
data given to estimate its common stock value employing price/earnings (P/E)
multiples.
Firm Expected EPS P/E Multiple
A 4.00 7.5
B 5.00 10.0
C 2.00 12.5
D 2.50 9.1
E 5.25 16.0