Question

Show all work and explain your answers clearly

1. You have been given the following projections (expectations) for Cali Corporation for the coming

year:

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Sales = 10,000 units

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Sales price per unit = $10

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Variable Cost per unit = $5

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Fixed Costs = $10,000

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Bonds outstanding = $15,000

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Interest rate on outstanding bonds = 8%

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Tax Rate = 40%

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Shares of common stock outstanding = 10,000 shares

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Beta = 1.4

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Riskfree Rate = 5%

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Market Return = 9%

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Dividend Payout Ratio = 60%

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Growth Rate = 8%

If the current stock price of Cali is $42 , is this a good buy?

3 pts . Show ALL work

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2. Stewart Industries expects to pay a $3.00 per share dividend on its common stock at the end of the year

(D1 = $3.00). The dividend is expected to grow 25 percent a year until t = 3, after which time the dividend

is expected to grow at a constant rate of 5 percent a year. The stock's beta is 1.2, the risk-free rate of

interest is 6 percent, and the market rate of return is 11 percent. What is the company's current stock

price?

2pts. Show all work and clearly explain your answer PLEASE

Answer 1

1. Using CAPM Model,
Ke = K_RF + beta (K_M - K_RF) = 5% + 1.4 (9% - 5%) = 10.6%

Using DDM Model,
Ke = D1/P0 + g
Calculation of D1:
Sales (10,000 x 10) = 100,000
Less variable cost (10,000 x 5) = 50,000
Less fixed cost =10,000

EBIT = 40,000
Less Interest (15,000 x 8%) = 1,200
EBT = 38,800
Less tax (40%) = 15,520
EAT = 23,280

EPS = 23,280/10,000 = $2.328

D1 = 60% x $2.328 = $1.3968

Putting Values in DDM Model,
Ke = D1/P0 + g
10.6% = 1.3968/P0 + 8%
1.3968/P0 = 10.6% - 8%
P0 = 1.3968/2.6%= $53.72

2. We first find Ke,
Ke = K_RF + beta (K_M - K_RF) = 6% + 1.2 (11% - 6%) = 12%

D1 = 3, D2 = 3 x 1.25 = 3.75, D3 = 4.6875, D4 = 4.921875
Terminal Price at Year 3,D_T = D4/(ke - g) = 4.921875/(0.12 - 0.05) = 70.3125

P0 = D1/(1.12) + D2/(1.12)² + (D3 + D_T)/(1.12)³ = 3/1.12 + 3.75/(1.12)² + (4.6875 + 70.3125)/(1.12)³ = 59.05