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PROBLEMS OF CHAPTER 07 - GITMAN - STOCK VALUATION

7.1 - 13.21Authorized shares available The Aspin Corporation's bylaws authorize the issuance of 2 million common shares. Currently, there are 1,400,000.
shares outstanding and 100 thousand shares in treasury. The company wishes to raise $48 million for the expansion of facilities. Discussions with its bank about
Investment indicates that the sale of new common shares will provide $60 per share to the company.
a. What is the maximum number of new common shares that the company can sell without obtaining additional authorization from the shareholders?
Based on the provided data and the result from item a, answer: will the company be able to obtain the necessary funds without receiving additional authorization?
c. What must the company do to obtain authorization to issue shares in a number greater than stipulated in a?

7.2 – 14.1 Preferred dividends Slater Lamp Manufacturing has preferred shares with a nominal value of $80 and an annual dividend of 11%.
a. Qual o valor do dividendo anual, em dólares? Caso seja pago trimestralmente, quanto será pago por trimestre?
b. If the preferred shares are not cumulative and the board of directors has failed to pay the preferred dividend in the last three
quarters, how much should be paid to preferred shareholders before paying dividends to common shareholders?

7.3 - 14.2 Preferred dividends In each of the cases presented in the table below, how many dollars of dividends per share should be paid to th
preferred shareholders before paying dividends to common shareholders?
Case Type Nominal value Dividend per share by Dividend period
period omitted
A Cumulative $ 80 $5 2
B Non-cumulative 110 8% 3
C Non-cumulative 100 $11 1
D Cumulative 60 8.5% 4
E Cumulative 90 9.0% 0

7.4 Convertible Preferred Shares The convertible preferred shares of Valerain Corp. have a fixed conversion rate of five common shares per
preferred stock. The preferred stock pays a dividend of $10 per year. The common stock is currently priced at $20 and pays a dividend of $1.
per year.
a. Judging by the conversion rate and the price of ordinary shares, what is the current conversion value of each preferred share?
b. If the preferred shares are being traded at $96 each, should an investor convert them into common shares?
c. What factors could cause an investor not to convert preferred shares?
7.5 Stock quotation Suppose that the following stock quote for Advance Business Machines (traded on the Nyse) had appeared in the edition of
Thursday, December 14, from the Wall Street Journal:
+ 3.2 84.13 51.25 AdvBusMach ABM 1.32 1.6 23 12432 81.75 +1.63
Based on this information, answer the questions:
a. On what day did the negotiations take place?

b. At what price was the stock traded at the close of the session on Wednesday, December 13?
c. What percentage variation occurred in the last stock price since the beginning of the year?
d. What is the price/earnings ratio of the company? What does it indicate?

e. What is the last price at which the stock was traded on the quoted day?
f. What dividend is expected for the current year?
g. What were the highest and lowest prices at which the stock was traded over the last 52 weeks?
h. How many shares were traded on the quoted day?
i. What price variation (if any) occurred between the quoted day and the previous day? What price did the stock close at the previous day?

7.6 - 7.14 Evaluation of ordinary shares - zero growth Scotto Manufacturing is a mature company in the machine components sector.
operators. The most recently paid dividend to ordinary shareholders was $2.40 per share. Due to its maturity and the stability of its
sales and profits, the company's management believes that dividends will remain at the current level in the future.
a. If the required return is 12%, what will be the value of Scotto's common stock?
b. If the perceived risk of the company by market participants suddenly increases, causing the required return to rise to 20%, what is the
value of the common stock?
c. Based on your results found at emaeb, what impact does risk have on value? Please explain your answer.
7.7 - Value of common stocks - zero growth Kelsey Drums, Inc. provides fine percussion instruments to various orchestras. The common dog
Class A of the company pays an annual dividend of $5 per share for the last 15 years. Management expects to continue paying this dividend in the future.
Sally Talbot bought one hundred class A ordinary shares of Kelsey ten years ago, at a time when the required return on the stock was 16%. She wants to sell.
your actions now. The required rate of return on the stock is currently 12%. What capital gain or loss will it have in the transaction with your shares?

7.8 - 7.15 Assessment of preferred stock A Jones Design wants to estimate the value of its outstanding preferred shares. The shares have a nominal value of
The $80 shares pay an annual dividend of $6.40 per share. Preferred stocks with similar risk are currently yielding an annual return of
9.3%.
a. What is the market value of the outstanding preferred shares?
b. If an investor buys the preferred stock at the price calculated in item a, how much could she gain or lose per share if she sold the stock when
Would the required return on preferred shares of similar risk increase to 10.5%? Explain your answer.
7.9 - 7.16 Value of the common stock - Constant growth Use the constant growth valuation model (Gordon model) to find the
value of each of the following companies.
Expected dividend for the next Growth rate of
Company year dividends Required return
A $ 1,20 8% 13%

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B 4.00 5 15
C 0.65 10 14
D 6.00 8 9
E 2.25 8 20

7.10 Value of common stock – constant growth A dividend of $1.20 per common share was paid by McCracken Roofing, Inc. last year.
The company expects that profits and dividends will grow at a constant rate of 5% per year in the foreseeable future.

a. Que taxa exigida de retorno dessa ação resultaria em um preço de $ 28?

b. If McCracken had profit and dividend growth at a rate of 10%, what required return would result in a price of $28?
7.11 - 7.17 Value of ordinary shares - constant growth Elky County Telephone paid the dividends indicated in the table over the last six years.
to follow
Yes 2003 2002 2001 2000 1999 1998
Dividend per share 2.87 2,76 2.60 2.46 2.37 2.25
The expected dividend for next year is $3.02.
a. If it is possible to obtain a return of 13% on investments with the same risk, what would be the maximum that one should pay for the stock?

b. If it were possible to obtain only 10% on the similar risk investment, what is the maximum that should be paid for the share?
c. Compare the results obtained in the intensity and discuss the impact of the variation on the value of the stock.

7.12 - 7.18 Value of common stock - variable growth A Newman Manufacturing is analyzing a cash purchase of Grips Toll stock. During the
In the year that just ended, Grips achieved a profit of $4.25 per share and paid dividends in cash of $2.55 per share.0It is expected that
the profits and dividends of Grips grow 25% per year for the next three years and then 10% per year indefinitely. What is the maximum price per share that the
Should Newman pay for the Grips if there is a required return of 15% on investments with similar risk characteristics?

7.13 Value of common shares - Variable growth Home Place Hotels, Inc. is starting a remodeling and expansion project that will last three
The construction activity will limit profits during this period, but once it is completed, it should allow the company to grow much more.
quickly in terms of profits and dividends. Last year, the company paid a dividend of $3.40. It expects zero growth in the next year.
In years 2 and 3, there should be a growth of 5%, and in year 4, of 15%; from year 5 onwards, the growth should be constant and equal to 10% per year. What is the price?
maximum that an investor demanding a 14% return should pay per ordinary share of Home Place Hotels
7.14 - 7.19 Value of ordinary share – Variable growth The most recent dividend of Lawrence Industry was $1.80 per share (D0= $1.80) and the return
the required return by the company is 11%. Find the market value of Lawrence's shares when:
a. Dividends are expected to grow by 8% annually for three years, followed by a constant annual growth rate of 5% thereafter.
fourth year to infinity.
b. Dividends are expected to grow at 8% annually for three years, followed by 0% annual growth from the fourth year onwards to infinity.
c. Dividends are expected to grow by 8% annually for three years, followed by a constant annual growth rate of 10% thereafter.
fourth year to infinity.
7.15 - 7.20 Value of common stock – all growth models You are evaluating the possibility of purchasing a small company that is
currently generating a cash flow of $42,500 after income tax0$42,500). Based on an investment opportunity study
with similar risk, you should obtain an 18% rate of return on the proposed purchase. Since you do not feel very secure about future cash flows,
You decide to estimate the company's value using various possible assumptions about the growth rate of cash flows.
a. What will the value of the company be if there is a forecast that cash flows will grow at a rate of 0% per year forever?
b. What is the value of the company if there is a forecast that cash flows will grow at a rate of 7% per year forever?
c. What is the value of the company if there is an expectation that cash flows will grow at a rate of 12% per year for the first two years, followed by a rate
constant annual rate of 7% from year 3 onwards?

7.16 – Evaluation of free cash flow Nabor Industries is examining the possibility of going public, but it does not feel confident about the fair price.
the launch of its shares. Before hiring an investment bank to assist him in the public offering, the company's managers decided
to estimate the value of your ordinary share. The financial director collected data so that the evaluation could be done using the free cash flow model.
The company's weighted average cost of capital is 11% and it has debt with a market value of $1,500,000 and preferred stock valued at
$400,000. The estimated free cash flows for the next five years, from 2004 to 2008, are shown in the table below. After 2008, the company
expect your free cash flow to grow 3% per year forever.
Year (t) Free cash flow (FCF)t)
2004 $ 200.000
2005 250,000
2006 310,000
2007 350,000
2008 390,000
a. Estimate the value of the company as a whole using the free cash flow valuation model.
b. Use the result obtained in item a and the previously provided data to find the total value of the ordinary shares of Nabor Industries.
c. If the company plans to issue 200 thousand ordinary shares, what will be the estimated value per share?
7.17 Use of the free cash flow valuation model to set the price of an Initial Public Offering (IPO) Suppose you have the opportunity
buying shares of CoolTech Inc. in an IPO offered at $12.50 per share. Although you are very interested in the company's shares, you would like to know
whether the price is fair. To determine the value of the shares, he decided to apply the free cash flow valuation model to the company's financial data obtained
from different sources. The compiled basic values are presented in the table below.

Free cash flow

Yes (t) (FCLt) Other data
2004 $ 700.000 Growth rate of FCL after 2007 forever = 2% per year
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2005 800,000 Weighted average cost of capital = 8%
2006 950.000Valor de mercado das dívidas = $ 2.700.000
2007 1.100.000Valor de mercado das ações preferenciais = $ 1.000.000
Number of ordinary shares outstanding = 1,100,000
a. Use the free cash flow valuation model to estimate the value of each ordinary share of CoolTech.
b. Based on the result of item a and the initial price of the stock, should you buy it?
c. After further analysis, you find that the growth rate of the FCL after 2007 will be 3%, not 2%. What changes would this cause in
your answers to the itensaeb?
7.18 - 7.21 Asset value and liquidation value Below is the balance sheet of Gallinas Industries:
Balance Sheet
Gallinas Industries
December 31
Assets Liabilities and Equity
Box $40,000 Accounts payable $100.000
Financial applications 60,000 Financial institutions to pay 30,000
Accounts receivable 120,000 Salaries to be paid 30,000
Stocks 160,000 Total of current liabilities $160.000
Total of current assets $380.000 Long-term payable $180.000
Land and buildings (net) $150.000 Preferred stocks 80,000
Machines and equipment (liquid) 250,000 Ordinary shares (10,000 shares) 360,000
Total fixed assets (net) $400.000
Total assets $780.000 Total of liabilities and net equity $780.000

The following additional information about the company is available:

(1) Preferred shares may be settled at book value.
Accounts receivable and inventories can be liquidated at 90% of their book value.
The company has 10,000 ordinary shares outstanding.
All interest and dividend payments are up to date.
The land and buildings can be liquidated for 130% of their accounting value.
Machines and equipment can be liquidated for 70% of their book value.
The cash and financial applications can be settled at book value.
Based on this information, answer:
What is the net asset value of Gallinas Industries' stock?
What is the liquidation value per share?
c) Compare, contrast and discuss the values found in the itensaeb.

7.19 - 7.22 Evaluation with the price/earnings multiple For each of the companies presented in the table below, use the data to estimate the value of their
ordinary shares, using price/earnings (P/E) multiples.
Company Expected LPA Price/earnings
A $3.00 6.2
B 4.50 10.0
C 1.80 12.6
D 2.40 8,9
E 5,10 15.0

7.20 - 7.23 Decision making and stock value The most recent dividend from REH Corporation was $3 per share, the expected growth rate of
the dividend is 5% per year and the required return is 15%. Several proposals are being considered by management to redirect activities of
company. Determine the impact of each of the proposals described below on the stock price and indicate the best alternative.
a. Não fazer nada, o que conservará inalterados os valores das variáveis financeiras.
b. Invest in a new machine that will raise the dividend growth rate to 6% and reduce the required return to 14%.
c. Eliminating a line of low-profit products will raise the dividend growth rate to 7% and the required return to 17%.
d. Merge with another company, which will reduce the growth rate to 4% and raise the required return to 16%.
e. Acquire a subsidiary of another company. The acquisition should increase the dividend growth rate by 8% and increase the required return to
17%.
7.21 - 7.24 Integrative problem – evaluation formulas and CAPM Given the following information regarding the stock of Foster Company, calculate its beta.
Current price of each ordinary share $50,00
Expected dividend per share for the next year $3.00
Constant annual growth rate of dividends 9%
Risk-free rate of return 7%
Market portfolio return 10%
7.22 - 7.25 Integrative problem - Risk and assessment Giant Enterprises has a beta of 1.20; the risk-free rate of return is currently 10%, and the return
of the market, of 14%. The company, which plans to pay a dividend per share of 2.60 next year, expects its future dividends to grow at a rate
annual compatible with that experienced in the period from 1997 to 2003, when the following dividends were paid:

Dividend per share Dividend per share

Yes Yes
2003 $ 2.45 1999 1.82
2002 2.28 1998 1.80
2001 2.10 1997 1.73
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2000 1.95
a. Use the capital asset pricing model (CAPM) to determine the required return of Giant Enterprises' stock.
b. Using the growth model and the result obtained in item a, estimate the value of the Giant Enterprises stock.
c. Explain what effect, if any, a reduction in beta would have on the stock value of Giant.

7.23 - 7.26 Integrative problem - evaluation and CAPMA Hamlin Company wants to determine the value of Craft Foundry, a company that is considering
acquire in cash. Hamlin wants to use the capital asset pricing model (CAPM) to determine the applicable discount rate and apply it
like a die in the constant growth model. Craft's stock is not traded on the stock exchange. After studying the betas of companies similar to Craft, whose
stocks are publicly traded, Hamlin believes that an appropriate beta for Craft's stock would be 1.25. The risk-free rate is currently 9% and the
market return of 13%. The dividend per share of Craft over the last six years is indicated in the table below.
Yes Dividend per share
2003 $3.44
2002 3.28
2001 3.15
2000 2.90
1999 2,75
1998 2.45
a) Considering that Craft is expected to pay a dividend of $3.68 next year, determine the maximum price that Hamlin should pay per share.
Craft.
b) Discuss the use of the CAPM to estimate the value of ordinary shares, and describe the effect on the resulting value of Craft from the following changes:

A reduction of 2% in the growth of dividends compared to what occurred in the period 1998 - 2003.
(2) A decrease in beta to 1
(3) An increase in the market return to 14%
Simultaneous occurrence of all these changes.
CHAPTER 7 CASE Assessment of the impact of the proposed investment with the risk of Suarez Manufacturing on the value of its debt security and
your action.
In early 2004, Inez Marcus, chief financial officer of Suarez Manufacturing, was tasked with assessing the impact of a proposed investment.
with risk regarding the values of the debt securities and the company's stock. To conduct the analysis, Inez collected the following information about the securities.
of debt and the company's action:
Títulos de dívida: A empresa tem, atualmente, uma emissão de títulos de dívida em circulação com valor de face de $1.000, uma taxa de juros declara no
9% coupon, and eighteen years remaining until maturity. After conducting a lot of research and consultations, Inez concluded that the investment proposal did not
could violate any of the provisions of the numerous debt titles. Since the investment proposal would increase the total risk of the company, it
Wait, if the investment is made, the required return on debt securities must increase to 10%.
ActionDuring the last five years (1999-2003), the annual dividends paid per ordinary share were:
Yes Dividend per share
2003 $1.90
2002 1.70
2001 1.55
2000 1.40
1999 1.30
The company believes that, without the proposed investment, the 2004 dividend will be $2.09 per share and the historical annual growth rate
(rounded to the nearest whole percentage) will continue in the future. Currently, the required return on common stock is 14%. The research conducted by Inez
It indicates that if the proposed investment is made, the dividend in 2004 will rise to $2.15 per share and the annual growth rate of the dividend will increase.
for 13%. She believes that, in the best case, the dividend would continue to grow at that annual rate forever, and that, in the worst case, the growth rate
the annual rate of 13% would continue only until 2006, returning in early 2007 to the rate that occurred between 1999 and 2003. As a consequence of the increase in associated risk
for the proposed investment, the required return on ordinary shares must increase by 2 percentage points, to 16% per year, regardless of growth in
dividends.
With this information, Inez now needs to assess the impact of the proposed investment on the market value of debt securities and the stock.
from Suarez. To simplify the calculations, she plans to round the historical dividend growth rate to the nearest whole percentage.
a. Calculate the current value of each debt security of Suarez Manufacturing
b. Calculate the current value per common share of Suarez Manufacturing
c. Find the value of the debt securities of Suarez, if the risky investment proposal is carried forward. Compare this value to the one found.
What effect could the investment proposal have on the company's debt holders? Explain.
d. Find the value of the ordinary share of Suarez, in the event that the proposed investment is made, assuming that the dividend growth rate is 13%.
forever. Compare this value to that obtained in item b. What effect would the proposed investment have on the shareholders' wealth? Explain your answer.
e. Based on the results found in emced, who wins and who loses with the proposed investment? The company should make the
investment? Why?
f. Redo the items assuming that at the beginning of 2007, the annual dividend growth rate returns to the rate that occurred between 1999 and 2003.