The indenture is a legal contract and can run into pages or more. Bond features which would be included are: the basic terms of the bond, the total amount of the bonds issued, description of the property used as security, repayment arrangements, call provisions, convertibility provisions, and details of protective covenants. The differences between preferred stock and debt are: a. The dividends on preferred stock cannot be deducted as interest expense when determining taxable corporate income.
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The value of any investment depends on the present value of its cash flows; i. The cash flows from a share of stock are the dividends. Investors believe the company will eventually start paying dividends or be sold to another company.
In general, companies that need the cash will often forgo dividends since dividends are a cash expense. Young, growing companies with profitable investment opportunities are one example; another example is a company in financial distress.
This question is examined in depth in a later chapter. The general method for valuing a share of stock is to find the present value of all expected future dividends. The dividend growth model presented in the text is only valid i if dividends are expected to occur forever; that is, the stock provides dividends in perpetuity, and ii if a constant growth rate of dividends occurs forever. A violation of the first assumption might be a company that is expected to cease operations and dissolve itself some finite number of years from now.
The stock of such a company would be valued by applying the general method of valuation explained in this chapter. This stock would also be valued by the general dividend valuation method explained in this chapter. The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred.
However, the preferred is less risky because of the dividend and liquidation preference, so it is possible the preferred could be worth more, depending on the circumstances. The two components are the dividend yield and the capital gains yield. For most companies, the capital gains yield is larger.
This is easy to see for companies that pay no dividends. For companies that do pay dividends, the dividend yields are rarely over five percent and are often much less. If the dividend grows at a steady rate, so does the stock price.
In other words, the dividend growth rate and the capital gains yield are the same. Presumably, the current stock value reflects the risk, timing and magnitude of all future cash flows, both short-term and long-term. If this is correct, then the statement is false.
Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred.
However, the final answer for each problem is found without rounding during any step in the problem. Basic 1. So, if we know the stock price today, we can find the future value for any time in the future we want to calculate the stock price. In this problem, we want to know the stock price in three years, and we have already calculated the stock price today. We need to find the required return of the stock.
Using the constant growth model, we can solve the equation for R. The required return of a stock is made up of two parts: The dividend yield and the capital gains yield.
The question asks for the dividend this year. The price of any financial instrument is the PV of the future cash flows. The price of a share of preferred stock is the dividend divided by the required return. This is the same equation as the constant growth model, with a dividend growth rate of zero percent.
Remember that most preferred stock pays a fixed dividend, so the growth rate is zero. This stock has a constant growth rate of dividends, but the required return changes twice. To find the value of the stock today, we will begin by finding the price of the stock at Year 6, when both the dividend growth rate and the required return are stable forever.
The price of the stock in Year 6 will be the dividend in Year 7, divided by the required return minus the growth rate in dividends. We need to find the price here since the required return changes at that time.
Here we have a stock that pays no dividends for 10 years. Once the stock begins paying dividends, it will have a constant growth rate of dividends. We can use the constant growth model at that point. We simply discount the future stock price at the required return. The price of a stock is the PV of the future dividends. This stock is paying five dividends, so the price of the stock is the PV of these dividends using the required return. With differential dividends, we find the price of the stock when the dividends level off at a constant growth rate, and then find the PV of the future stock price, plus the PV of all dividends during the differential growth period.
Here we need to find the dividend next year for a stock experiencing differential growth. We know the stock price, the dividend growth rates, and the required return, but not the dividend. Now we need to find the equation for the stock price today.
The constant growth model can be applied even if the dividends are declining by a constant percentage, just make sure to recognize the negative growth. We are given the stock price, the dividend growth rate, and the required return, and are asked to find the dividend.
The price of a share of preferred stock is the dividend payment divided by the required return. We know the dividend payment in Year 5, so we can find the price of the stock in Year 4, one year before the first dividend payment. To find the number of shares owned, we can divide the amount invested by the stock price. The share price of any financial asset is the present value of the cash flows, so, to find the price of the stock we need to find the cash flows.
The cash flows are the two dividend payments plus the sale price. We also need to find the aftertax dividends since the assumption is all dividends are taxed at the same rate for all investors.
Here we have a stock paying a constant dividend for a fixed period, and an increasing dividend thereafter. We need to find the present value of the two different cash flows using the appropriate quarterly interest rate. Here we need to find the dividend next year for a stock with nonconstant growth. The required return of a stock consists of two components, the capital gains yield and the dividend yield.
To find the current dividend, we can use the information provided about the net income, shares outstanding, and payout ratio. The total dividends paid is the net income times the payout ratio. To find the dividend per share, we can divide the total dividends paid by the number of shares outstanding. First, we need to find the annual dividend growth rate over the past four years. To do this, we can use the future value of a lump sum equation, and solve for the interest rate.
We can find the price of all the outstanding company stock by using the dividends the same way we would value an individual share. Since the earnings have increased, the price of the stock will increase. If the company does not make any new investments, the stock price will be the present value of the constant perpetual dividends.
The investment is a one-time investment that creates an increase in EPS for two years. The price of the stock is the present value of the dividends. Since earnings are equal to dividends, we can find the present value of the earnings to calculate the stock price. Also, since we are excluding taxes, the earnings will be the revenues minus the costs.
We simply need to find the present value of all future earnings to find the price of the stock. The value of a share of stock in a company is the present value of its current operations, plus the present value of growth opportunities. To find the present value of the growth opportunities, we need to discount the cash outlay in Year 1 back to the present, and find the value today of the increase in earnings.
The increase in earnings is a perpetuity, which we must discount back to today. If the company continues its current operations, it will not grow, so we can value the company as a cash cow.
To find the value of the investment, we need to find the NPV of the growth opportunities. The initial cash flow occurs today, so it does not need to be discounted. The earnings growth is a perpetuity. Using the present value of a perpetuity equation will give us the value of the earnings growth one period from today, so we need to discount this back to today.
The investment occurs every year in the growth opportunity, so the opportunity is a growing perpetuity. So, we first need to find the growth rate. During year 3, 30 percent of the earnings will be reinvested. The perpetuity formula values that stream as of year 3. Since the investment opportunity will continue indefinitely and grows at 6 percent, apply the growing perpetuity formula to calculate the NPV of the investment as of year 2.
Discount that value back two years to today. We are asked to find the dividend yield and capital gains yield for each of the stocks. All of the stocks have a 20 percent required return, which is the sum of the dividend yield and the capital gains yield.
To find the components of the total return, we need to find the stock price for each stock. Using this stock price and the dividend, we can calculate the dividend yield. The capital gains yield for the stock will be the total return required return minus the dividend yield. High-growth stocks have an appreciable capital gains component but a relatively small current income yield; conversely, mature, negative-growth stocks provide a high current income but also price depreciation over time.
We can then use this interest rate to find the equivalent annual dividend. In other words, when we receive the quarterly dividend, we reinvest it at the required return on the stock.
So, the effective quarterly rate is: Effective quarterly rate: 1. This would assume the dividends increased each quarter, not each year. During year 3, 20 percent of the earnings will be reinvested.
Solutions manual Corporate Finance 9th editor by Ross, Westerfield, and Jaffe
Peer group analysis involves comparing the financial ratios and operating performance of a particular firm to a set of peer group firms in the same industry or line of business. Both allow an investigation into what is different about a company from a financial perspective, but neither method gives an indication of whether the difference is positive or negative. It could mean that the company had been facing liquidity problems in the past and is rectifying those problems, or it could mean the company has become less efficient in managing its current accounts. Similar arguments could be made for a peer group comparison. A company with a current ratio lower than its peers could be more efficient at managing its current accounts, or it could be facing liquidity problems.
Solutions Manual to Corporate Finance 1 to 7 Editon by Ross Westerfield