Practice Problems(Stock Valuation)1. Michael’s, Inc. just paid $1.40 to their shareholders as the annual dividend. Simultaneously,the company announced that future dividends will be increasing by 4.5 percent. If yourequire an 8 percent rate of return, how much are you willing to pay to purchase one shareof Michael’s stock?2. Angelina’s made two announcements concerning their common stock today. First, thecompany announced that their next annual dividend has been set at $2.16 a share.Secondly, the company announced that all future dividends will increase by 4 percentannually. What is the maximum amount you should pay to purchase a share ofAngelina’s stock if your goal is to earn a 10 percent rate of return?3. A stock pays a constant annual dividend and sells for $31.11 a share. If the rate ofreturn on this stock is 9 percent, what is the dividend amount?4. You have decided that you would like to own some shares of GH Corp. but need anexpected 12 percent rate of return to compensate for the perceived risk of such ownership.What is the maximum you are willing to spend per share to buy GH stock if the companypays a constant $3.50 annual dividend per share?5. Turnips and Parsley common stock sells for $39.86 a share at a market rate of return of9.5 percent. The company just paid their annual dividend of $1.20. What is the rate ofgrowth of their dividend?6. B&K Enterprises will pay an annual dividend of $2.08 a share on their common stocknext week. Last year, the company paid a dividend of $2.00 a share. The companyadheres to a constant rate of growth dividend policy. What will one share of B&Kcommon stock be worth ten years from now if the applicable discount rate is 8percent?7. The Red Bud Co. pays a constant dividend of $1.20 a share. The company announcedtoday that they will continue to do this for another 3 years after which time they willdiscontinue paying dividends permanently. What is one share of this stock worth todayif the required rate of return is 7 percent?8. Bill Bailey and Sons pays no dividend at the present time. The company plans to startpaying an annual dividend in the amount of $.30 a share for two years commencingtwo years from today. After that time, the company plans on paying a constant $1 ashare dividend indefinitely. How much are you willing to pay to buy a share of thisstock if your required return is 14 percent?9. Lee Hong Imports paid a $1.00 per share annual dividend last week. Dividends areexpected to increase by 5 percent annually. What is one share of this stock worth toyou today if the appropriate discount rate is 14 percent?(Portfolio and CAPM)10. You want your portfolio beta to be 1.20. Currently, your portfolio consists of $100invested in stock A with a beta of 1.4 and $300 in stock B with a beta of .6. You haveanother $400 to invest and want to divide it between an asset with a beta of 1.6 and arisk-free asset. How much should you invest in the risk-free asset?11. You have a $1,000 portfolio which is invested in stocks A and B plus a risk-free asset.$400 is invested in stock A. Stock A has a beta of 1.3 and stock B has a beta of .7.How much needs to be invested in stock B if you want a portfolio beta of .90?12. You recently purchased a stock that is expected to earn 12 percent in a booming economy, 8percent in a normal economy and lose 5 percent in a recessionary economy. There is a 15percent probability of a boom, a 75 percent chance of a normal economy, and a 10 percentchance of a recession. What is your expected rate of return on this stock?13. The Inferior Goods Co. stock is expected to earn 14 percent in a recession, 6 percent in anormal economy, and lose 4 percent in a booming economy. The probability of a boom is20 percent while the probability of a normal economy is 55 percent and the chance of arecession is 25 percent. What is the expected rate of return on this stock?14. You are comparing stock A to stock B. Given the following information, which one ofthese two stocks should you prefer and why?ifReturnRateofState of Probability of State OccursA Stock BEconomy State of Economy StockBoom 60% 9% 15%Recession 40% 4% -6%15. Zelo, Inc. stock has a beta of 1.23. The risk-free rate of return is 4.5 percent and the marketrate of return is 10 percent. What is the amount of the risk premium on Zelo stock?16. You own a portfolio with the following expected returns given the various states of theeconomy. What is the overall portfolio expected return?ofRateReturnStateofProbabilityofEconomy State of Economy ifOccursStateBoom 15% 18%Normal 60% 11%Recession 25% -10%17. What is the expected return on a portfolio which is invested 20 percent in stock A, 50percent in stock B, and 30 percent in stock C?State of Probability of Returns if State OccursEconomy State of Economy StockA StockB Stock CBoom 20% 18% 9% 6%Normal 70% 11% 7% 9%Recession 10% -10% 4% 13%18. What is the portfolio variance if 30 percent is invested in stock S and 70 percent isinvested in stock T?State of Probability of Returns if State OccursS Stock TStockEconomy State of EconomyBoom 40% 12% 20%Normal 60% 6% 4%19. What is the standard deviation of a portfolio that is invested 40 percent in stock Q and 60percent in stock R?State of Probability of Returns if State OccursQ Stock REconomy State of EconomyStockBoom 25% 18% 9%Normal 75% 9% 5%20. Your portfolio has a beta of 1.18. The portfolio consists of 15 percent U.S. Treasury bills,30 percent in stock A, and 55 percent in stock B. Stock A has a risk-level equivalent to thatof the overall market. What is the beta of stock B?21. You would like to combine a risky stock with a beta of 1.5 with U.S. Treasury bills in sucha way that the risk level of the portfolio is equivalent to the risk level of the overall market.What percentage of the portfolio should be invested in Treasury bills?22. The market has an expected rate of return of 9.8 percent. The long-term governmentbond is expected to yield 4.5 percent and the U.S. Treasury bill is expected to yield 3.4percent. The inflation rate is 3.1 percent. What is the market risk premium?23. The risk-free rate of return is 4 percent and the market risk premium is 8 percent. Whatis the expected rate of return on a stock with a beta of 1.28?24. The common stock of Flavorful Teas has an expected return of 14.4 percent. Thereturn on the market is 10 percent and the risk-free rate of return is 3.5 percent. Whatis the beta of this stock?25. Which one of the following stocks is correctly priced if the risk-free rate of return is3.6 percent and the market rate of return is 10.5 percent?Stock Beta ExpectedReturnA .85 9.2%B 1.08 11.8%C 1.69 15.3%D .71 7.8%E 1.45 12.3%(Capital Structure and WACC)26. Watson’s Automotive has a $400,000 bond issue outstanding that is selling at 102percent of face value. Watson’s also has 4,500 shares of preferred stock and 21,000shares of common stock outstanding. The preferred stock has a market price of $44 ashare compared to a price of $21 a share for the common stock. What is the weight ofthe debt as it relates to the firm’s weighted average cost of capital?27. Gillian’s Boutique has 850,000 shares of common stock outstanding at a market priceof $16 a share. The company also has 15,000 bonds outstanding that are quoted at 98percent of face value. What weight should be given to the common stock whenGillian’s computes their weighted average cost of capital?28. Jack’s Construction Co. has 80,000 bonds outstanding that are selling at par value.Bonds with similar characteristics are yielding 8.5 percent. The company also has4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for$40 a share. The U.S. Treasury bill is yielding 4 percent and the market risk premiumis 8 percent. Jack’s tax rate is 35 percent. What is Jack’s weighted average cost ofcapital?29. Peter’s Audio Shop has a cost of debt of 7 percent, a cost of equity of 11 percent, and a costof preferred stock of 8 percent. The firm has 104,000 shares of common stock outstandingat a market price of $20 a share. There are 40,000 shares of preferred stock outstanding at amarket price of $34 a share. The bond issue has a total face value of $500,000 and sells at102 percent of face value. The company’s tax rate is 34 percent. What is the weightedaverage cost of capital for Peter’s Audio Shop?(M&M)30. Thompson & Thomson is an all equity firm that has 500,000 shares of stock outstanding.The company is in the process of borrowing $8 million at 9 percent interest to repurchase200,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?31. Uptown Interior Designs is an all equity firm that has 40,000 shares of stock outstanding.The company has decided to borrow $1 million to buy out the shares of a deceasedstockholder who holds 2,500 shares. What is the total value of this firm if you ignore taxes?32. The Winter Wear Company has expected earnings before interest and taxes of $2,100, anunlevered cost of capital of 14 percent and a tax rate of 34 percent. The company also has$2,800 of debt that carries a 7 percent coupon. The debt is selling at par value. What is thevalue of this firm?33. Gail’s Dance Studio is currently an all equity firm that has 80,000 shares of stockoutstanding with a market price of $42 a share. The current cost of equity is 12 percent andthe tax rate is 34 percent. Gail is considering adding $1 million of debt with a coupon rateof 8 percent to her capital structure. The debt will be sold at par value. What is the leveredvalue of the equity?34. Wild Flowers Express has a debt-equity ratio of .60. The pre-tax cost of debt is 9 percentwhile the unlevered cost of capital is 14 percent. What is the cost of equity if the tax rate is34 percent?35. Your firm has a $250,000 bond issue outstanding. These bonds have a 7 percent coupon,pay interest semiannually, and have a current market price equal to 103 percent of facevalue. What is the amount of the annual interest tax shield given a tax rate of 35 percent? 36. Bertha’s Boutique has 2,000 bonds outstanding with a face value of $1,000 each and acoupon rate of 9 percent. The interest is paid semi-annually. What is the amount of theannual interest tax shield if the tax rate is 34 percent?37. Your firm has expected earnings before interest and taxes of $1,600. Your unlevered cost ofcapital is 13 percent and your tax rate is 34 percent. You have debt with both a book and aface value of $2,500. This debt has an 8 percent coupon and pays interest annually. What isyour weighted average cost of capital?38. A firm has debt of $5,000, equity of $16,000, a leveraged value of $8,900, a cost of debt of8 percent, a cost of equity of 12 percent, and a tax rate of 34 percent. What is the firm’sweighted average cost of capital?(Answer Keys)1.$41.802.$36.003.$2.804.$29.175. 6.3 percent6.$76.977.$3.158.$5.259.$11.6710.$011.$54312.7.30 percent13.6.00 percent14.Stock A; because it has a higher expected return and appears to be less risky than stock B.15.6.77 percent16.6.8 percent17.8.25 percent18..00405619.2.6 percent20.1.6021..3322.6.4 percent23.14.24 percent24.1.6825.C26.39 percent27.48 percent28.10.38 percent29.9.14 percent30.$20.0 million31.$16.0 million32.$10,85233.$2.7 million34.15.98 percent35.$6,12536.$61,20037.11.77 percent38.10.40 percent。