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# Variable growth, Preferred stock, market value, bond coupon rate

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1. Common stock value-Variable growth

Newman Manufacturing is considering a cash purchase of the stock of Grip's Tool. During the year just completed, Grips earned \$4.25 per share and paid cash dividends of \$2.55 per share (D0 = \$2.55). Grip's earnings and dividends are expected to grow at 25% per year for the next 3 years, after which they are expected to grow at 10% per year to infinity. What is the maximum price per share that Newman should pay for Grips if it has a required return of 15% on investments with risk characteristics similar to those of Grips?

2. Common stock value - Constant growth

Use the constant-growth model (gordon model) to find the value of each firm shown in the following table.

Firm Dividend expected next year dividend growth rate required return

A \$1.20 8% 13%

B 4.00 5 15

C 0.65 10 14

D 6.00 8 9

E 2.25 8 20

3. Preferred stock valuation Jone Design wishes to estimate the value of its outstanding preferred stock. The preferred issue has an \$80 par value and pays an annual dividend of \$6.40 share. Similar-risk preferred stocks are currently earning a 9.3% annual rate of return.

a. What is the market value of the outstanding preferred stock?
b. If an investor purchases the preferred stock at the value calculated in part a, how much does she gain or lose per share if she sells the stock when the required return on similar-risk preferred has risen to 10.5%? Explain.

4. Authorize and available shares Aspin Corporation's charter authorizes issuance of 2,000,000 share of common stock. Currently, 1,400,000 shares are outstanding and 1,000,000 shares are being held as treasury stock. The firm wishes to raise \$48,000,000 for a plant expansion. Discussion with its investment bankers indicate that the sale of new common stock will net the firm \$60 per share.

a. What is the maximum number of new shares of common stock that the firm can sell without receiving further authorization from the shareholder?
b. Judging on the basis of the data given and your finding in part a, will the firm be able to raise the needed funds without receiving further authorization?
c. What must the firm do to obtain authorization to issue more than the number of shares found in part a.

Bond value and changing required returns Midland Utilities has outstanding a bonds that will mature to its \$1,000 par value in 12 years. The bond has a coupon interest rate of 11% and pays interest annually.

a. Find the value of the required return is (1) 11%, (2) 15% and (3) 8%.
b. Plot your findings in part a on a set of "required return (x-axis)-market value of bond (y-axis)" axes.
c. Use your finding in a and b to discuss the relationship between the coupon interest rate on a bond and the required return and the market value of the bond relative to its par value.
d. What two possible reasons could cause the required return to different from the coupon interest rate?

Yield to maturity The Salem Company bond currently sells for \$955, has a 12% coupon interest rate and a \$1000 par value, pays interest annually, and has 15 years to mature.

a. Explain the relationships that exist between the coupon interest rate and yield to maturity and the par value and market value of a bond.

#### Solution Preview

Please see attachment for format of tables and graphs.

1. COMMON STOCK VALUE-VARIABLE GROWTH
Newman Manufacturing is considering a cash purchase of the stock of Grip's Tool. During the year just completed, Grips earned \$4.25 per share and paid cash dividends of \$2.55 per share (D0 = \$2.55). Grip's earnings and dividends are expected to grow at 25% per year for the next 3 years, after which they are expected to grow at 10% per year to infinity. What is the maximum price per share that Newman should pay for Grips if it has a required return of 15% on investments with risk characteristics similar to those of Grips?

NOTE: Double click the table to see the formulas used.

2. COMMON STOCK VALUE - CONSTANT GROWTH
Use the constant-growth model (Gordon model) to find the value of each firm shown in the following table.
Firm Dividend expected next year Growth rate Required return Value of firm
A \$1.20 (A) 8% (B) 13% (C) \$24.00 =A/(C - B)
B \$4.00 5% 15% \$40.00
C \$0.65 10% 14% \$16.25
D \$6.00 8% 9% \$600.00
E \$2.25 8% 20% \$18.75

3. PREFERRED STOCK VALUATION.
Jones Design wishes to estimate the value of its outstanding preferred stock. The preferred issue has an \$80 par value and pays an annual dividend of \$6.40 share. Similar-risk preferred stocks are currently earning a 9.3% annual rate of return.
a. What is the market value of the ...

#### Solution Summary

Variable growth, preferred stock, market value and the bond coupon rate is examined.

\$2.19