AACSB: Analytical Thinking

Difficulty: 3 Hard

Section: 6.4 Valuing Stocks Using Free Cash Flows Topic: Free cash flow models and valuations Bloom’s: Level 4 Analyze

AACSB: Analytical Thinking

81) Duncan Street Mills is an all-equity firm with 32,000 shares of stock outstanding. The firm expects sales of \$520,000 next year. Sales are expected to grow by 8 percent for the following 2 years and then level off to a constant 3 percent growth rate. Net cash flow varies in direct proportion to sales and is currently equal to 16 percent of sales. The required return is 17 percent. What is the estimated current value of one share of stock?

A) \$20.10

B) \$22.03

C) \$18.94

D) \$19.76

E) \$18.01

Explanation: Net cash flowYear 1 = 0.16 × \$520,000 = \$83,200

Terminal valueYear 3 = (\$83,200 × 1.082 × 1.03) / (0.17 − 0.03) = \$713,970.10

Total firm value = \$83,200 / 1.17 + (\$83,200 × 1.08) / 1.172 + [(\$83,200 × 1.082) +

\$713,970.10] / 1.173 = \$643,125.76

Price per share = \$643,125.76 / 32,000 = \$20.10

Difficulty: 3 Hard

Section: 6.4 Valuing Stocks Using Free Cash Flows Topic: Free cash flow models and valuations Bloom’s: Level 4 Analyze

AACSB: Analytical Thinking

82) Hanover Inc. is an all-equity firm with 27,500 shares of stock outstanding. The firm expects sales of \$429,000 next year. Sales are expected to grow by 30 percent the following year and then level off to a constant 6 percent growth rate. Net cash flow varies in direct proportion to sales and is currently equal to 21 percent of sales. The required return for this firm is 18 percent. What is the estimated current value of one share of stock?

A) \$32.85

B) \$36.21

C) \$30.71

D) \$35.20

E) \$31.19

Explanation: Net cash flowYear 1 = 0.21 × \$429,000 = \$90,090

Terminal valueYear 2 = (\$90,090 × 1.30 × 1.06) / (0.18 − 0.06) = \$1,034,533.50

Current firm value = \$90,090 / 1.18 + [(\$90,090 × 1.30) + \$1,034,533.50] / 1.182 = \$903,444.92

Price per share = \$903,444.92 / 27,500 = \$32.85

Difficulty: 3 Hard

Section: 6.4 Valuing Stocks Using Free Cash Flows Topic: Free cash flow models and valuations Bloom’s: Level 4 Analyze

AACSB: Analytical Thinking

83) Theo owns 49,800 of the 120,000 outstanding shares of BBE Inc. The share price is \$28.64. Each share is granted one vote for each open seat on the board of directors. Currently, there are three open seats. Theo wants to be on the board and is assuming that no one, other than himself,

will vote for him. How much additional money, if any, must he invest in BBE to guarantee his election if the firm uses a straight voting system?

A) \$0

B) \$287,403.64

C) \$292,128.00

D) \$292,156.64

E) \$287,375.00

Explanation: Total number of shares needed = (0.5 × 120,000) + 1 = 60,001 shares

Additional shares needed = 60,001 − 49,800 = 10,201 shares

Additional cost to purchase shares = 10,201 × \$28.64 = \$292,156.64

Difficulty: 3 Hard

Section: 6.5 Some Features of Common and Preferred Stocks

Topic: Shareholder voting Bloom’s: Level 4 Analyze AACSB: Analytical Thinking