6.
Preferred stock valuation
Segwick Manufacturing has an outstanding preferred stock issue with a par value of $50 per
share. The preferred shares pay dividends annually at a rate of 5%.
a. What is the annual dividend on Segwick’s preferred stock?
Annual dividend= Price of preferred stock x annual dividend rate
= 50 x 5%
= $2.50 per share
b. If investors require a return of 6% on this stock and the next dividend is payable one year
from now, what is the price of Segwick’s preferred stock?
Annual dividend= Price of preferred stock x annual dividend rate
2.50 = Price of preferred stock x 5%
= $41.67
c. Suppose that Segwick has not paid dividends on its preferred share in the past two years,
but investors believe it will start paying dividends again in one year. What is the value of
Segwick’s preferred stock if it is cumulative and if investors require a 6% rate of return?
Cash flow b: $41.67
Cash flow a: PV= 5/ (1+0.06)^1 = $4.72
The total value of the preferred stock= $41.67+ $4.72 = $46.39
12. Common stock value: Constant growth
Christine Law is the Chief Investment Officer for Elite Investment Company. She is now
calculating the equity value of Rays Food Company. In 2018, Elite paid a dividend of $5 per
share. By 2022, that dividend had grown to $5.72 per share. The company paid $5.15, $5.40
and $5.62 per share in 2019, 2020 and 2021 respectively.
What is the growth rate for each year? Calculate the average growth rate of the stock. In 2022,
the company paid the $5.72 dividend. Christine believes that the company’s dividends will
grow constantly at the average growth rate calculated. If the required return is 10%, what is the
value of the stock?
Year Dividend per share Growth rate
2018 $5
2019 5.15 0.03
2020 5.4 0.0485
2021 5.62 0.0407
2022 5.72 0.0178
Average growth rate: (0.03+0.0485+0.0407+1.78)/4
= 0.0343
= [5.72x(1+0.0343)]/(0.1-0.0343)
= $90
14. Common stock value: Variable growth
Moors Tools is considering a cash-purchase of the stock of Crooks Moldings. During the year
just completed, Crooks earned $4.50 per share and paid cash dividend of $2.30 per share
(DO=2.30). Crook’s earnings and dividends are expected to grow 20% per year for the next
two years, after which they are expected to grow at 5% per year forever. What is the maximum
price per share that Moors should pay for Crooks if it has a required return of 12% on
investment with risk characteristics similar to those of Crooks?
Year 1: Year 2:
D1= 2.30x (1+0.20) D2= 2.30x (1+0.20)^2
= 2.30x 1.20 = 2.30x 1.44
= 2.76 = 3.33
PV1= 2.76/ (1+0.12)= $2.46
PV2= 3.33/ (1+0.12)^2= $2.65
Total: 2.46+2.65= 5.11
P2= 3.48/ (0.12-0.05)= 49.71
PV: 49.71/ (1+0.12)^2= 39.63
P0= 2.46+2.65+39.63= $44.73
18. Free cash flow valuation
Jackson Ltd. is considering going public but is unsure of a fair offering price for the company.
Before hiring an investment banker to assist in making the public offering, managers at Jackson
have decided to make their own estimate of the firm’s common stock value. The firm’s CFO
has gathered data for performing the valuation using the free cash flow valuation model.
The firm’s weighted average cost of capital is 10%, and it has $200000 of the debt and $500000
of preferred stock in term of market value. The estimated free cash flows over the next five
years appear below. Beyond 2024, the firm expects its free cash flow to grow by 4% per year
forever.
a. Estimate the value of Jackson Ltd. by using the free cash flow valuation model.
Year Free Cash Flow (1+wacc)^t PV
2020 220000 1100 200000
2021 250000 1210 206611.57
2022 300000 1331 225394.44
2023 320000 1464 218564.46
2024 350000 1611 217322.46
PV of perpetual cash flow at the end of 2024: 364000/ (0.1-0.04) = $6066666.67
PV as of now: 6066666.67/ 1.1^5= $3766922.69
Total firm value: 1067841.60+ 3766922.69
= $4834815.47
b. Use your finding in part a, along with the data provided above, to find Jackson Ltd. common
stock value.
= 4834764.30 – 200000 – 500000
= $4134764.30
VS: total value of common stock
VD: total debt
VP: total value of preferred stock
c. If the firm plans to issue 200000 shares of common stock, what is its estimated value per
share?
Value per common stock: Vs/ Common shares
= 4134815.47/ 200000
= $20.67 per share
20. Book and liquidation value. (Ch)
The balance sheet for Macadamia Industries is as follows.
Additional information with respect to the firm is available:
1. Accounts receivable and inventories can be liquidated at 95% of book value.
2. The firm has 10000 shares of common stock outstanding.
3. Preferred stock can be liquidated at book value.
4. All interest and dividends are currently paid up.
5. Land and buildings can be liquidated at 150% of book value.
6. Machinery and equipment can be liquidated at 80% of book value.
7. Cash and marketable securities ca be liquidated at the book value.
Using the information provided, answer the following:
a. What is Macadamia Industries’ book value per share?
Book value per share
: (Book value of assets – book value of liabilities – book value of preferred stock)/
Outstanding shares
= (1560000 – 680000 – 160000)/ 10000
= $72 per share
b. What is its liquidation value per share?
i. Account receivable: 240000x0.95= 228000
ii. Inventories: 320000x 0.95= 304000
iii. Land and buildings: 300000x 1.5= 450000
iv. Machinery and equipment: 500000x 0.8= 400000
v. Cash and marketable securities: 800000-120000= 80000
Macadamia Industries
Assets $ Liquidation value for common stock $
Cash 80000 Liquidation value assets 1560000
Marketable securities 120000 Less:
Accounts receivable 228000 Current liabilities 320000
Inventories 320000 Long-term debt 360000
Total current assets 760000 Preference share capital 160000
Land and buildings 450000 Available for common shareholders 720000
Machinery and equipment 400000
Total fixed assets 800000
Total liquidation value of 1560000
assets
Liquidation value per share
= value available for common shareholder/ common shares
= 720000/ 10000
= $72 per share
c. Compare, contrast and discuss the values found in parts a and b.
Book value per share: 124
Liquidation value per share: 140.50
The values calculated in Parts (a) and (b) are similar. However, this is likely to be a rare
case where the book value and the liquidation value are the same. Normally, the book value
is likely to be higher than the liquidation value.