Chapter 7-Stock Valuation Exercise Problems-Part 1

1. Scotto Manufacturing Co. has 15 million common shares

outstanding and has recently paid $2.40 per share in
dividends to its common stockholders. It is expected that
the firm will maintain the dividends at this level for the
foreseeable future. Scotto has generated $35 Million in Net
Income in the most recent year.

a. Assume that the current risk free rate is 4% and the
market return is expected to be 12%. If the Scottos
stock beta is 1.35 then what is the required rate of
return for the firm?


b. Based on your finding in part a. what will the firms
stock value be?



c. Now assume that the firms beta jumps to 2 then what
will the price of Scottos stock be?








d. Scottos management is considering investing in a new
project overseas and they believe that this will induce
the firm to grow at a rate of 5% for the foreseeable
future. Assuming that the firms beta continues to be
1.35 what is the expected stock price for the firm.




e. Scottos management wants a second opinion about the
stock valuation and they have collected the following
information on their industry peer firms. Based on this
information what is expected price per share for Scotto?
Industry Peer EPS Stock Price
1. $2.50 $22.5
2. $0.75 $5.25
3. $1.28 $7.75





2. Using the Gordon dividend growth model and the P/E
multiples approach determine the stock value for Microsoft
Corporation
i) Use the current 30 year T-Bond rate as your risk
free rate; Refer to Pg 205 of your textbook and
obtain the historical return on large company
stocks as an approximation of the market returns
(12.3%)
ii) Obtain all other estimates including beta,
growth rate forecast, dividends, P/E ratios for
rival firms etc from Y! Finance.





3. Consider the data that you pulled up for MSFT.

a. What is the current and expected dividend yield for
MSFT?



b. What is the expected capital gains yield for MSFT?






c. Based on your answers above what is the total return
you would expect to earn on MSFT?





d. Compare the expected return you have calculated above
to the required rate of return of MSFT. Is MSFT
overvalued, undervalued or correctly valued?






e. Perform the same calculations and determine if GE is
over or undervalued.



4. Slater Lamp Manufacturing has an outstanding issue of
preferred stock with an $80 Par Value and an 11% dividend
which is paid quarterly.

a. If the required rate of return on Slaters preferred stock
is 12% then what is the preferred stocks price?





b. Estimate the value of the preferred stock if the required
rate of return is lower at 10%?




c. Estimate the value of the preferred stock if the required
rate of return is 11%?