Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 4, Problem 24PS
Two-stage DCF model Compost Science Inc. (CSI) is in the business of converting Boston’s sewage sludge into fertilizer. The business is not in itself very profitable. However, to induce CSI to remain in business, the Metropolitan District Commission (MDC) has agreed to pay whatever amount is necessary to yield CSI a 10% book
- a. Suppose CSI continues on this growth trend. What is the expected long-run
rate of return from purchasing the stock at $100? What part of the $100 price is attributable to thepresent value of growth opportunities? - b. Now the MDC announces a plan for CSI to treat Cambridge sewage. CSI’s plant will, therefore, be expanded gradually over five years. This means that CSI will have to reinvest 80% of its earnings for five years. Starting in year 6, however, it will again be able to pay out 60% of earnings. What will be CSI’s stock price once this announcement is made and its consequences for CSI are known?
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Compost Science Incorporated (CSI) is in the business of converting Boston's sewage sludge into fertilizer. The business is not in itself
very profitable. However, to induce CSI to remain in business, the Metropolitan District Commission (MDC) has agreed to pay whatever
amount is necessary to yield CSI a 12% book return on equity. At the end of the year, CSI is expected to pay a $5 dividend. It has been
reinvesting 30% of earnings and growing at 3% a year.
a-1. Suppose CSI continues on this growth trend. What is the expected long-run rate of return from purchasing the stock at $100?
Note: Do not round intermediate calculations. Enter your answer as a percent rounded to the nearest whole number.
a-2. What part of the $100 price is attributable to the present value of growth opportunities?
Note: Do not round intermediate calculations. Round your answer to 2 decimal places.
b. Now the MDC announces a plan for CSI to treat Cambridge sewage. CSI's plant will, therefore, be expanded…
Compost Science Incorporated (CSI) is in the business of converting Boston's sewage sludge into fertilizer. The business
is not in itself very profitable. However, to induce CSI to remain in business, the Metropolitan District Commission (MDC)
has agreed to pay whatever amount is necessary to yield CSI a 12% book return on equity. At the end of the year, CSI is
expected to pay a $5 dividend. It has been reinvesting 30% of earnings and growing at 3% a year.
a-1. Suppose CSI continues on this growth trend. What is the expected long-run rate of return from purchasing the stock
at $100?
Note: Do not round intermediate calculations. Enter your answer as a percent rounded to the nearest whole number.
a-2. What part of the $100 price is attributable to the present value of growth opportunities?
Note: Do not round intermediate calculations. Round your answer to 2 decimal places.
b. Now the MDC announces a plan for CSI to treat Cambridge sewage. CSI's plant will, therefore, be expanded…
We are going to explore the differences between two different companies, both from
the same sector, firms A and B. They differ in their reinvestment abilities. Firm A and
Firm B are both financed with equity only.
At the end of their business year, both firms report $1,000m in revenue. The net
income is $200m for both firms. Assume that management is able to maintain a
constant net profit margin of 20%.
• Firm A is capable of achieving 8% revenue growth annually by investing 27% of
their net income.
.
Firm B is capable of achieving 8% revenue growth annually by investing 40% of
their net income.
Assume that this difference persists into the future.
a) Find the value of firms A and B. Use a discount rate of 16% for both firms.
Value of firm A in millions:
Value of firm B in millions:
b) The forward P/E ratio of a company is the price of a share divided by next year's
earnings per share, or its value divided by next year's earnings. What is the forward
P/E ratio of firms A and B?
P/E…
Chapter 4 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 4 - True/false True or false? a. All stocks in an...Ch. 4 - Dividend discount model Respond briefly to the...Ch. 4 - Dividend discount model Company X is expected to...Ch. 4 - Dividend discount model Company Y does not plow...Ch. 4 - Constant-growth DCF model Company Zs earnings and...Ch. 4 - Dividend discount model Company Z-prime is like Z...Ch. 4 - Dividend discount model If company Z (see Problem...Ch. 4 - Prob. 8PSCh. 4 - Prob. 9PSCh. 4 - Free cash flow Under what conditions does r, a...
Ch. 4 - Prob. 11PSCh. 4 - Prob. 12PSCh. 4 - Horizon value Suppose the horizon date is set at a...Ch. 4 - Stock quotes Go to finance.yahoo.com and get...Ch. 4 - Two-stage DCF model Consider the following three...Ch. 4 - Constant-growth DCF model Pharmecology just paid...Ch. 4 - Two-stage DCF model Company Qs current return on...Ch. 4 - Cost of equity capital Each of the following...Ch. 4 - Growth opportunities Alpha Corps earnings and...Ch. 4 - Prob. 23PSCh. 4 - Two-stage DCF model Compost Science Inc. (CSI) is...Ch. 4 - DCF and free cash flow Permian Partners (PP)...Ch. 4 - DCF and free cash flow Construct a new version of...Ch. 4 - Valuing a business Mexican Motors market cap is...Ch. 4 - Valuing Tree cash flow Phoenix Corp. faltered in...Ch. 4 - Constant-growth DCF formula The constant-growth...Ch. 4 - DCF valuation Portfolio managers are frequently...Ch. 4 - Valuing a business Construct a new version of...
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