1. For purposes of this exercise, let’s take a closer

1. For purposes of this exercise, let’s take a closer look at the stock of Exxon Mobil (XOM). Use websites such as Yahoo! Finance, Google Finance, MSN Money (www.msn.com/en-us/money/markets), and Morning star to find the company’s current stock price and see its performance relative to the overall market in recent months. What is Exxon Mobil’s current stock price? How has the stock performed relative to the market over the past few months?
2. Check recent headlines on the website to see the company’s recent news stories. Have there been any recent events impacting the company’s stock price, or have things been relatively quiet?
3. To provide a starting point for gauging a company’s relative valuation, analysts often look at a company’s price-to-earnings (P/E) ratio. Go to the website’s summary quote or key statistics screen to see XOM’s forward P/E ratio, which uses XOM’s next 12-month estimate of earnings in the calculation, and to see its current P/E ratio. What are the firm’s forward and current P/E ratios?
4. To put XOM’s P/E ratio in perspective, it is useful to see how this ratio has varied over time. (If you go to Morning star and click on the valuation tab, you should see the 10-year summary of its P/E ratio. In addition, it shows a 10-year summary for the S&P 500 P/E ratio as well as Exxon Mobil’s 5-year average.) Is XOM’s current P/E ratio well above or well below its 5-year average? Explain why the current P/E
deviates from its historical trend. On the basis of this information, does XOM’s current P/E suggest that the stock is undervalued or overvalued? Explain.
5. To put the firm’s current P/E ratio in perspective, it is useful to compare this ratio with that of other companies in the same industry. To see how XOM’s P/E ratio stacks up to its peers, refer to Google Finance’s Related Companies screen. (If you click “Add or remove columns,” you will find that you can obtain comparisons of a number of key statistics for either the most recent year or quarter.) For the most part, is XOM’s P/E ratio above or below that of its peers? In Chapter 4, we discussed the various factors that may influence P/E ratios. Can any of these factors explain why XOM’s P/E ratio differs from its peers? Explain.
6. In the text, we discussed using the discounted model to estimate a stock’s intrinsic value. To keep things as simple as possible, let’s assume at first that XOM’s is expected to grow at a constant rate of 5% annually over time. So, g 5 5%. If so, the intrinsic value equals D1/(rs 2 g), where D1 is the expected annual 1 year from now, rs is the stock’s required rate of return, and g is the dividend’s constant growth rate. Go back to the summary (overview) screen and find XOM’s current Multiply this by 1 1 g to arrive at an estimate of D1.7. The required return on equity, rs, is the final input needed to estimate intrinsic value. For our purposes, you can assume a number (say, 9% or 10%) or you can use the CAPM to calculate an estimate of the cost of equity, using the data available on the Internet. (For more details, look at the Taking a Closer Look exercise for Chapter 8.) Having decided on your best estimates for D1, rs, and g, you can calculate XOM’s intrinsic value. Be careful to make sure that the long-run growth rate is less than the required rate of return. How does this estimate compare with the current stock price? Does your preliminary analysis suggest that XOM is undervalued or overvalued? Explain.
8. It is often useful to perform a sensitivity analysis, where you show how your estimate of intrinsic value varies according to different  estimates of D1, rs, and g. To do so, recalculate your intrinsic value estimate for a range of different estimates for each of these key inputs. One convenient way to do this is to set up a simple data table in Excel. On the basis of this analysis, what inputs justify the current stock price?
9. Until now, we have assumed that XOM’s will grow at a long-run constant rate of 5%. To gauge whether this is a reasonable assumption, it’s helpful to look at XOM’s history. If you go to the MSN Money website (www.msn.com/en-us/money/markets) and go to the annual income statement  financials screen, you should see the firm’s annual over the past 4 years. On the basis of this information, what has been the average annual growth rate? On the basis of the history and your assessment of XOM’s future payout policies, do you think it is reasonable to assume that the constant growth model is a good proxy for intrinsic value? If not, how would you use the available data on the Internet to estimate intrinsic value using the non constant growth model?
10. Finally, you can also use the information on the Internet to value the entire This approach requires that you estimate XOM’s annual free cash flows. Once you estimate the value of the firm’s operations and the value of any non-operating assets, you subtract the value of debt and preferred stock to arrive at an estimate of the company’s equity value. By dividing this value by the number of shares of outstanding, you calculate an alternative estimate of the stock’s intrinsic value. Although this approach may take additional time and involves more judgment concerning forecasts of future free cash flows, you can use the and growth forecasts on the Internet as useful starting points. If you go to the annual cash flow statement financials screen, you will find historical annual values. These numbers are useful as a starting point to arrive at an estimate for the next year. Note  that you can also obtain historical free cash flows over a 5-year period from Morning star. After entering the company’s ticker symbol, simply select the Financials tab, select Cash flow, and make sure the annual dialog box is selected. (To find any definitions on Morning star, scroll down to the bottom of the page, and select Glossary. On the next screen you will see an alphabetic index; just click the first letter of the term for the definition you’re interested in.)

Answer the following questions:a. Assuming a rate of 10% annually,

Answer the following questions:
a. Assuming a rate of 10% annually, find the FV of $1,000 after 5 years.
b. What is the investment’s FV at rates of 0%, 5%, and 20% after 0, 1, 2, 3, 4, and 5 years?
c. Find the PV of $1,000 due in 5 years if the is 10%.
d. What is the rate of return on a security that costs $1,000 and returns $2,000 after 5 years?
e. Suppose California’s population is 36.5 million people and its population is expected to grow by 2% annually. How long will it take for the population to double?
f. Find the PV of an ordinary that pays $1,000 each of the next 5 years if the interest rate is 15%. What is the annuity’s FV?
g. How will the PV and FV of the in part f change if it is an due?
h. What will the FV and the PV be for $1,000 due in 5 years if the interest rate is 10%, semiannual compounding?

i. What will the annual payments be for an ordinary for 10 years with a PV of $1,000 if the interest rate is 8%? What will the payments be if this is an due?
j. Find the PV and the FV of an investment that pays 8% annually and makes the following end-of-year payments:

k. Five banks offer of 6% on deposits, but A pays interest annually, B pays semiannually, C pays quarterly, D pays monthly, and E pays daily.

What effective annual rate does each bank pay? If you deposit $5,000 in each bank today, how much will you have in each bank at the end of 1 year? 2 years?

If all of the banks are insured by the government (the FDIC) and thus are equally risky, will they be equally able to attract funds? If not (and the TVM is the only consideration), what nominal rate will cause all of the banks to provide the same
effective annual rate as Bank A?

Suppose you don’t have the $5,000 but need it at the end of 1 year. You plan to make a series of deposits—annually for A, semiannually for B, quarterly for C, monthly for D, and daily for E—with payments beginning today. How large must the payments be to each bank?

Even if the five banks provided the same effective annual rate, would a rational investor be indifferent between the banks? Explain.
l. Suppose you borrow $15,000. The loan’s annual interest rate is 8%, and it requires four equal end-of-year payments. Set up an amortization schedule that shows the annual payments, interest payments, principal repayments, and beginning and ending loan balances.

Assume that today is December 31, 2018, and that the

Assume that today is December 31, 2018, and that the following information applies to Abner Airlines:
● After-tax operating income [EBIT(1 – T)] for 2019 is expected to be $400 million.
● The depreciation expense for 2019 is expected to be $140 million.
● The capital expenditures for 2019 are expected to be $225 million.
● No change is expected in net operating working capital.
● The is expected to grow at a constant rate of 6% per year.
● The required return on equity is 14%.
● The WACC is 10%.
● The firm has $200 million of non operating assets.
● The market value of the company’s debt is $3.875 billion.
● 200 million shares of stock are outstanding.

Using the corporate valuation model approach, what should be the company’s stock price today?

The future earnings, dividends, and common stock price of Callahan

The future earnings, dividends, and price of Callahan Technologies Inc. are expected to grow 6% per year. Callahan’s currently sells for $22.00 per share, its last was $2.00, and it will pay a $2.12 at the end of the current year.
a. Using the DCF approach, what is its cost of common equity?
b. If the firm’s beta is 1.2, the risk-free rate is 6%, and the average return on the market is 13%, what will be the firm’s cost of common equity using the CAPM approach?
c. If the firm’s bonds earn a return of 11%, based on the bond-yield-plus-risk-premium approach, what will be rs? Use the midpoint of the risk premium range discussed in Section 10-5 in your calculations.
d. If you have equal confidence in the inputs used for the three approaches, what is your estimate of Callahan’s cost of common equity?

1. Begin by looking at the historical performance of the

1. Begin by looking at the historical performance of the overall stock market. Typically, on most of the financial websites you can enter S&P 500 and go right to the index’s summary page. You will see a quick summary of the market’s performance over the past 24 hours and 12 months. How has the market performed over the past year?
2. On the summary screen, you should see an interactive chart. Typically, you can chart performance over the last 24 hours, 1 month, 6 months—up to 10 years, or even longer. Select different time periods and watch how the graph changes. On this screen you should also see a menu to select historical prices (historical data). Some websites will not only show daily activity but also weekly or monthly activity. In addition, some websites will allow you to download the data into an Excel spreadsheet.
3. Now let’s take a closer look at the of four companies: Colgate Palmolive (Ticker 5 CL), Campbell Soup (CPB), Motorola Solutions (MSI), and Tiffany & Co (TIF). Before looking at the data, which of these companies would you expect to have a relatively high beta (greater than 1.0) and which of these companies would you expect to have a relatively low beta (less than 1.0)?
4. Select one of the four listed in question 3 by entering the company’s ticker symbol on the financial website you have chosen. On the screen you should see the interactive chart. Select the six-month time period and compare the performance to the S&P 500’s performance on the graph by adding the S&P 500 to the interactive chart. Has the stock outperformed or underperformed the overall market during this time period?
5. Go back to the summary page to see an estimate of the company’s beta. What is the company’s beta? What was the source of the estimated beta? Realize that if you go to another website, the beta shown could be different due to measurement differences.
6. What is the company’s current yield? What has been its total return to investors over the past year? Over the past 3 years? (Remember that total return includes the yield plus any capital gains or losses.) You will have to go to more than one website to find this information. MSN Money (www.msn .com/en-us/money/markets) gives DPS information over the past 4 years on the detailed Income Statement Financials page. (Be sure to enter the ticker symbol in the quote search box located in the middle of your screen—not the web search box at the top of your screen.) You can use the price information to calculate yield and capital gains yield. Yahoo! Finance provides historical price information.
7. Assume that the risk-free rate is 4% and the market risk premium is 5%. What is the required return on the company’s stock?
8. Repeat the same exercise for each of the three remaining companies. Do the reported betas confirm your earlier intuition? In general, do you find that the higher-beta tend to do better in up markets and worse in down markets? Explain.

Assume that it is now January 1, 2019. Wayne-Martin Electric

Assume that it is now January 1, 2019. Wayne-Martin Electric Inc. (WME) has developed a solar panel capable of generating 200% more electricity than any other solar panel currently on the market. As a result, WME is expected to experience a 15% annual growth rate for the next 5 years. Other firms will have developed comparable technology by the end of 5 years, and WME’s growth rate will slow to 5% per year indefinitely. Stockholders require a return of 12% on WME’s stock. The most recent annual

dividend (D0), which was paid yesterday, was $1.75 per share.
a. Calculate WME’s expected dividends for 2019, 2020, 2021, 2022, and 2023.
b. Calculate the value of the stock today, P0. Proceed by finding the present value of the dividends expected at the end of 2019, 2020, 2021, 2022, and 2023 plus the present value of the stock price that should exist at the end of 2023. The year end 2023 stock price can be found by using the constant growth equation. Notice that to find the December 31, 2023, price, you must use the expected in 2024, which is 5% greater than the 2023 Calculate the expected yield (D1/P0), capital gains yield, and total return
(dividend yield plus capital gains yield) expected for 2019. (Assume that P0 = P0 and
recognize that the capital gains yield is equal to the total return minus the yield.) Then calculate these same three yields for 2024.
d. How might an investor’s tax situation affect his or her decision to purchase of companies in the early stages of their lives, when they are growing rapidly, versus of older, more mature firms? When does WME’s stock become “mature” for purposes of this question?
e. Suppose your boss tells you she believes that WME’s annual growth rate will be only
12% during the next 5 years and that the firm’s long-run growth rate will be only 4%.
Without doing any calculations, what general effect would these growth rate changes have on the price of WME’s stock?
f. Suppose your boss also tells you that she regards WME as being quite risky and that
she believes the required rate of return should be 14%, not 12%. Without doing any calculations, determine how the higher required rate of return would affect the price of the stock, the capital gains yield, and the yield. Again, assume that the long-run growth rate is 4%.

1. As a first step, we need to estimate what

1. As a first step, we need to estimate what percentage of MMM’s capital comes from debt, preferred stock, and common equity. This information can be found on the firm’s latest annual (As of year end 2016, MMM had no preferred stock.) Total debt includes all interest-bearing debt and is the sum of short-term debt and long-term debt.
a. Recall that the weights used in the WACC are based on the company’s target capital structure. If we assume that the company wants to maintain the same mix of capital that it currently has on its what weights should you use to estimate the WACC for MMM?
b. Find MMM’s market capitalization, which is the market value of its common equity. Using the sum of its short-term debt and long-term debt from the (we assume that the market value of its debt equals its book value) and its market capitalization, recalculate the firm’s debt and common equity weights to be used in the WACC equation. These weights are approximations of market-value weights. Be sure not to include accruals in the debt calculation.
2. Once again we can use the CAPM to estimate MMM’s cost of equity. From the Internet, you can find a number of different sources for estimates of beta—select the measure that you think is best, and combine this with your estimates of the risk-free rate and the market risk premium to obtain an estimate of its cost of equity. (See the Taking a Closer Look problem in Chapter 8 for more details.) What is your estimate for MMM’s cost of equity? Why might it not make much sense to use the DCF approach to estimate MMM’s cost of equity?
3. Next, we need to calculate MMM’s We can use different approaches to estimate it. One approach is to take the company’s interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical equals the yield to in today’s market (i.e., if MMM’s outstanding bonds are trading at close to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated will likely understate the true Another approach is to try to find this number in the notes to the company’s annual report by accessing the company’s home page and its Investor Relations section. Alternatively, you can go to other external sources, such as Morningstar.com, which will provide yield to information on the firm’s various bond issues. Finally, you can go to FINRA’s Bond Center (finra-markets.morningstar .com/BondCenter/) and do a quick search for MMM’s bond issues. A longer-term issue’s YTM could provide an estimate of the firm’s current to be used in the WACC calculation. Remember that you need the after-tax to calculate a firm’s WACC, so you will need MMM’s tax rate (which has averaged around 30% in recent years). What is your estimate of MMM’s after-tax a. What is your estimate of MMM’s WACC using the book-value weights calculated in question 1a?
b. What is your estimate of MMM’s WACC using the market-value weights calculated in question 1b?
c. Explain the difference between the two WACC estimates. Which estimate do you prefer? Explain your answer.
d. How confident are you in the estimate chosen in part c? Explain your answer.

Empire Electric Company (EEC) uses only debt and common equity.

Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 9% as long as it finances at its target capital structure, which calls for 35% debt and 65% common equity. Its last (D0) was $2.20, its expected constant growth rate is 6%, and its sells for $26. EEC’s tax rate is 40%. Two projects are available: Project A has a rate of return of 12% and Project B’s return is 11%. These two projects are equally risky and about as risky as the firm’s existing assets.
a. What is its cost of common equity?
b. What is the WACC?
c. Which projects should Empire accept?

Olsen Outfitters Inc. believes that its optimal capital structure consists

Olsen Outfitters Inc. believes that its optimal consists of 55% common equity and 45% debt, and its tax rate is 40%. Olsen must raise additional capital to fund its upcoming expansion. The firm will have $4 million of retained earnings with a cost of rs 5 11%. New in an amount up to $8 million would have a cost of re 5 12.5%. Furthermore, Olsen can raise up to $4 million of debt at an interest rate of rd 5 9% and an additional $5 million of debt at rd 5 13%. The CFO estimates that a proposed expansion would require an investment of $8.2 million. What is the WACC for the last dollar raised to complete the expansion?

You must evaluate the purchase of a proposed spectrometer for

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $140,000, and it would cost another $30,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $60,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%, as discussed in Appendix 12A. The equipment would require an $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $50,000 per year in before-tax labor costs. The firm’s marginal federal-plus-state tax rate is 35%.
a. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow?
b. What are the project’s annual cash flows in Years 1, 2, and 3?
c. If the WACC is 9%, should the spectrometer be purchased? Explain