Question

1. If you’re a stockholder, you should always try to purchase stocks with a price above the stock price’s intrinsic value.   

True or False?

2. Use the Security Market Line approach to determine the required rate of return. If you had a risk free rate of 8%, market rate of 12% and a beta of 1.1, what is the required rate of return?

3. Using the Constant Growth Model, what is this stock’s intrinsic value:

Dividends today are $5.00 and expected to increase 3% annually. The required rate of return is 12% and the growth rate is 6%.

4. Corporate Valuation Model: What is the price per share for the following company:

Free cash flow is $500,000         Interest is 7%  

Market value of Debt is $300,000     Market value of Preferred Stock is $100,000

Shares outstanding are 50,000

Answer 1

1.

If you’re a stockholder, you should always try to purchase stocks with a price above the stock price’s intrinsic value.

False

If stock price is above intrinsic value then stock is overvalued

2.

Using CAPM model,

Required Rate = 0.08 + 1.10(0.12 - 0.08)

Required Rate = 12.40%

3.

Using DDM Model,

Stock Price = 5(1.03)/)(0.12 - 0.06)

Stock Price = $85.83

4.

Value of Operations = 500,000/0.07 = $7,142,857

Price per Share = (7,142,857 - 300,000 - 100,000)/50,000

Price per Share = $134.86