# Fin515 Wk 4

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• Published: November 22, 2012

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7-2 - Boehm Incorporated is expected to pay a \$1.50 per share dividend at the end of this year (i.e., D1 = \$1.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs, is 15%. What is the value per share of Boehm’s stock? D1= \$1.50 per share

g = 7%
rs= 15%
What is the value of a share of Boehm Stock?
P^0 =   D1 /(rs – g)
P^0 =   1.50/(0.15-0.07)
P^0 =   \$18.75

7-4 - Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of \$5 at the end of each year. The preferred sells for \$50 a share. What is the stock’s required rate of return? Dividend = \$5

Preferred   = \$50
What is the stock’s required rate of return
^P 0 = D/rs
rs = D/^P 0
rs = 5/50
rs = 0.10 or 10%

7-5 - A company currently pays a dividend of \$2 per share (D0 = \$2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk- free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price? D0 = \$2.00

g = 20% for 2 years
g = 7% there after
Bi = 1.2
Rf = 7.5%
RPm = 4%

Rs = Rf +(bi* RPm)
Rs = 7.5 +(1.2*4)
Rs = 12.3
What is your estimate of the stock’s current price?
D0 \$2.00
g0 to 1 20.0%
g1 to 2 20.0%
gn 7.0%
rs 12.3%
Year
1 2
D1 D2
Expected dividends \$2.40 \$2.88

Expected P2 \$58.14

PV of expected dividends \$4.42
PV of expected P2 \$46.10

Expected P0 \$50.53

Problems (p. 371)
9-2 After-Tax Cost of Debt
LL Incorporated’s currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL’s after-tax cost of debt? After Tax cost of debt = rd * (1- tx rate)

0.08 * (1 - 0.35)
= 0.08 * (0.65)
= 0.052