Exam 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions): Assuming that riskless rate is 4.2% and the market premium is 6.2% calculate Zonk's cost of equity capital:

Shady Sunglasses operates retail sunglass kiosks in shopping malls.Below is information related to the company: Using the above information and assuming that steady-state growth in year 2017 and beyond will be 4% calculate Shady Sunglasses value per share.

Normally,valuation methods are designed to produce reliable estimates of the value of a firm's ______________________________.

One rationale for using expected dividends in valuation is

Why are dividends value-relevant to common equity shareholders?

The CAPM computes expected rates of return on common equity capital using the following model: E[R_Ej] = E[R_F] + b_j x {E[R_M] - E[R_F]} What are the roles of each of the three components of this model?

Equity valuation models based on dividends,cash flows,and earnings have been the topic of many theoretical and empirical research studies in recent years.All of the following are true regarding these studies except:

Explain why analysts and investors use risk-adjusted expected rates of return as discount rates in valuation.Why do risk-adjusted expected rates of return increase with risk?

All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except:

The following data pertain to Loren Corporation (dollar amounts in thousands): Using this information,calculate the following: a.Loren Corporation's cost of equity capital b.The weight on debt capital that should be used to calculate Loren's weighted-average cost of capital. c.Loren Corporation's weighted-average cost of capital

Carr Industries must raise $100 million on January 1,2012 to finance its expansion into a new market.The company will use the money to finance construction of four retail outlets and a distribution center.The stores are expected to open later this year.The CFO has come up with three alternatives for raising the money: 1)Issue $100 million of 8% nonconvertible debt due in 20 years. 2)Issue $100 million of 6% nonconvertible preferred stock (100,00 shares). 3)Issue $100 million of common stock (1 million shares). The company's internal forecasts indicate the following 2012 year-end amounts before any option is chosen: Carr has no preferred stock outstanding but currently has 10 million shares of common stock outstanding.EPS has been declining for the past several years.Earnings in 2011 were $1 per share,which was down from $1.10 during 2010,and management wants to avoid another decline during 2012.One of the company's existing loan agreements requires a debt-to-equity ratio to be less than 2.Carr pays taxes at a 40% rate. Required: 1.Assess the impact of each financing alternative on 2012 EPS and the year-end debt to equity ratio. 2.Which financing alternative would you recommend and why?

Bridgetron An analyst wants to value the sum of the debt and equity capital of the firm and is provided with the following information: An analyst wants to value the common shareholders' equity of Bridgetron,compute the relevant cost of capital that should be used.

The dividends valuation approach measures value-relevant dividends to encompass various transactions between the firm and the common shareholders.What transactions should the analyst include in value-relevant dividends for purposes of implementing the dividends valuation model? Why?

Returns on systematic risk-free securities (like U.S.Treasury securities)should exhibit what type of correlation with returns on a diversified marketwide portfolio of stocks?

In what case will using dividends expected to be paid to shareholders yield the same valuation for the firm as using free cash flows expected to be generated by the firm?

Identify the types of firm-specific factors that increase a firm's nondiversifiable risk (systematic risk).Identify the types of firm-specific factors that increase a firm's diversifiable risk (idiosyncratic risk or nonsystematic risk).Why do models of risk-adjusted expected returns include no expected return premia for diversifiable risk?

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions): Using the above information,calculate Zonk's weighted-average cost of capital:

To determine the appropriate weights to use in the weighted average cost of capital,an analyst will need to determine the ______________________________ of the debt,preferred stock and common equity capital.

In some valuation scenarios,such as a leveraged buyout,it may be necessary to adjust the market equity beta to reflect a ________________________________________. new capital structure

Conceptually,why should an analyst expect the dividends valuation approach to yield equivalent value estimates to the valuation approach that is based on free cash flows available to be distributed to common equity shareholders?