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Chapter 8
Basic Stock Valuation
ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS
8-1 See the model IFM13Ch08 BOC.xlsx for the answer to this question. There we show how
to find the stock price under some assumed conditions.
8-2 Again, see the model in IFM13Ch08 BOC.xlsx. We show some alternative conditions, or
scenarios, and the stock price under those scenarios.
8-3 Again, see the model IFM13Ch08 BOC.xlsx. We show how to use Excel to find the stock
price under conditions of nonconstant growth. Note, though, that we do assume constant
growth after some number of years.
8-4 Again, see the model IFM13Ch08 BOC.xlsx. Everything up to this point could be found
fairly easily with a calculator, but it would be difficult to get an exact solution to Question
4 with a calculator. In the model, we show how to use Excel Goal Seek function to find
the expected rate of return.
8-5 The dividend growth model is only appropriate for companies that pay dividends and are
expected to grow at a predictable rate, with this rate leveling off to a constant rate sometime
in the future. It can also be applied to companies that do not pay dividends but are expected
to do so in the forecastable future, but here the analysis becomes more speculative.
It is especially difficult to justify using the discounted dividend model for tech stock
IPOs, where the company is not likely to ever pay a dividend because if it is successful it
is likely to be acquired in a merger. The acquisition price, if it could be estimated, and if
the timing of the acquisition could be forecasted, could be treated like a dividend, but this
is really stretching things.
For companies where the discounted dividend model is inappropriate, the free cash
flow valuation model in which we discount free cash flows, not dividends, is best. Free
cash flows can be calculated for any firm, whether it pays a dividend or not, so this model
is appropriate to all firms.
Answers and Solutions: 8- 1

© 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
ANSWERS TO END-OF-CHAPTER QUESTIONS
8-1 a. A proxy is a document giving one person the authority to act for another, typically the
power to vote shares of common stock. If earnings are poor and stockholders are
dissatisfied, an outside group may solicit the proxies in an effort to overthrow
management and take control of the business, known as a proxy fight. The preemptive
right gives the current shareholders the right to purchase any new shares issued in
proportion to their current holdings. The preemptive right may or may not be required
by state law. When granted, the preemptive right enables current owners to maintain
their proportionate share of ownership and control of the business. It also prevents the
sale of shares at low prices to new stockholders which would dilute the value of the
previously issued shares. Classified stock is sometimes created by a firm to meet
special needs and circumstances. Generally, when special classifications of stock are
used, one type is designated “Class A”, another as “Class B”, and so on. Class A might
be entitled to receive dividends before dividends can be paid on Class B stock. Class
B might have the exclusive right to vote. Founders’ shares are stock owned by the
firm’s founders that have sole voting rights but restricted dividends for a specified
number of years.
b. The free cash flow model defines the total value of a company as the value of operations
plus the value of nonoperating assets.
The value of operations is the present value of all the future expected free cash
flows when discounted at the weighted average cost of capital:

FCFt
Vop(at time 0) =  .
t =1 (1 + WACC)
t
Nonoperating assets include investments in marketable securities and non-

controlling interests in the stock of other companies, and other financial securities.
c. Constant growth occurs when a firm’s earnings, dividends, and free cash flows grow
at some constant long-term rate. In this situation, the constant growth model can be
used to estimate the present value of the growing cash flows or dividends. For free cash
flows, the present value is:
FCF1 FCF0 (1 + g L )
Vop (constant growth) = =
WACC − g L WACC − g L
Answers and Solutions: 8 - 2

or in part.
When applied to dividends, the model is:
^ = D0 (1 + g L ) = D1
P 0
rs − g L rs − g L
The horizon date is the last year in a cash flow forecast. Cash flows may grow
unevenly during the forecast period, but are assumed to grow at a constant rate for all
periods after the horizon date.
The horizon value is the value all cash flows beyond the horizon date when
discounted back to the horizon date.
When applied to free cash flows, the horizon value is the value of operations at the
end of the explicit forecast period. It is equal to the present value of all free cash flows
beyond the forecast period, discounted back to the end of the forecast period at the
weighted average cost of capital. Because growth after the horizon is constant, the
constant growth model can be applied at the horizon date:
FCFT +1 FCFT (1 + g L )
HVT = Vop(at time T) = = .
WACC − g L WACC − g L
When applied to dividends, the horizon value is the intrinsic stock price at the end
of the explicit forecast period. It is equal to the present value of all dividends beyond
the forecast period, discounted back to the end of the forecast period at the required
rate of return on stock. Because growth after the horizon is constant, the constant
growth model can be applied at the horizon date:
̂ T = DT+1 = DT (1+gL)
Horizon value for stock = P
rs -gL rs -gL
d. A multistage model is used when the growth rate is nonconstant for several years before
becoming constant. In this case, the constant growth model is applied at the end of the
forecast horizon when the growth rate has become constant. The total present value of
cash flows is the present value of all cash flows in the forecast periods plus the present
value of the horizon value:
T
FCF HV
Vop,0 =  (1 + WACC
t + T
) (1 + WACC)T
t
t =1

or in part.
When applied to dividends, the present value of dividends is:
T
D P̂
^=
P 0  (1 + tr ) t + (1 + Tr T
t =1 s L)
e. Estimated value ( P̂0 ) is the present value of the expected future cash flows. The market
price (P0) is the price at which an asset can be sold.
f. The required rate of return on common stock, denoted by rs, is the minimum acceptable
rate of return considering both its riskiness and the returns available on other
investments. The expected rate of return, denoted by ^rs, is the rate of return expected
on a stockn given its current price and expected future cash flows. If the stock is in
equilibrium, the required rate of return will equal the expected rate of return. The
realized (actual) rate of return, denoted by r̄ s, is the rate of return that was actually
realized at the end of some holding period. Although expected and required rates of
return must always be positive, realized rates of return over some periods may be
negative.
g. The capital gains yield results from changing prices and is calculated as (P 1 - P0)/P0,
where P0 is the beginning-of-period price and P1 is the end-of-period price. For a
constant growth stock, the capital gains yield is g, the constant growth rate. The
dividend yield on a stock can be defined as either the end-of-period dividend divided
by the beginning-of-period price, or the ratio of the current dividend to the current
price. Valuation formulas use the former definition. The expected total return, or
expected rate of return, is the expected capital gains yield plus the expected dividend
yield on a stock. The expected total return on a bond is the yield to maturity.
h. Preferred stock is a hybrid--it is similar to bonds in some respects and to common stock
in other respects. Preferred dividends are similar to interest payments on bonds in that
they are fixed in amount and generally must be paid before common stock dividends
can be paid. If the preferred dividend is not earned, the directors can omit it without
throwing the company into bankruptcy. So, although preferred stock has a fixed
payment like bonds, a failure to make this payment will not lead to bankruptcy. Most
preferred stocks entitle their owners to regular fixed dividend payments.
8-2 True. The value of a share of stock is the PV of its expected future dividends. If the two
investors expect the same future dividend stream, and they agree on the stock’s riskiness,

or in part.
then they should reach similar conclusions as to the stock’s value.
8-3 A perpetual bond is similar to a no-growth stock and to a share of preferred stock in the
following ways:
1. All three derive their values from a series of cash inflows--coupon payments from the
perpetual bond, and dividends from both types of stock.
2. All three are assumed to have indefinite lives with no maturity value (M) for the
perpetual bond and no capital gains yield for the stocks.
8-4 The first step is to find the value of operations by discounting all expected future free cash
flows at the weighted average cost of capital. The second step is to find the total corporate
value by summing the value of operations, the value of nonoperating assets, and the value
of growth options. The third step is to find the value of equity by subtracting the value of
debt and preferred stock from the total value of the corporation. The last step is to divide
the value of equity by the number of shares of common stock.

or in part.
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
8-1 D0 = $1.50; g1-3 = 5%; gn = 10%; D1 through D5 = ?
D1 = D0(1 + g1) = $1.50(1.05) = $1.5750.

D2 = D0(1 + g1)(1 + g2) = $1.50(1.05)2 = $1.6538.
D3 = D0(1 + g1)(1 + g2)(1 + g3) = $1.50(1.05)3 = $1.7364.
D4 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn) = $1.50(1.05)3(1.10) = $1.9101.
D5 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn)2 = $1.50(1.05)3(1.10)2 = $2.1011.
8-2 D1 = $1.50; g = 6%; rs = 13%; P̂0 = ?
D1 $1.50
P̂0 = = = $21.43.
rs − g 0.13 − 0.06

8-3 P0 = $22; D0 = $1.20; g = 10%; P̂1 = ?; r s= ?
P̂1 = P0(1 + g) = $22(1.10) = $24.20.
 D1 $1.20(1.10)
rs = +g= + 0.10
P0 $22
$1.32 
= + 0.10 = 16.00%. r s = 16.00%.
$22
8-4 Dps = $5.00; Vps = $50; rps = ?
D ps $5.00
rps = = = 10%.
v ps $50.00

or in part.
8-5 0 1 2 3
| | | |
D0 = 2.00 D1 D2 D3
P̂2
Step 1: Calculate the required rate of return on the stock:
rs = rRF + (rM - rRF)b = 7.5% + (4%)1.2 = 12.3%.
Step 2: Calculate the expected dividends:
D0 = $2.00
D1 = $2.00(1.20) = $2.40
D2 = $2.00(1.20)2 = $2.88
D3 = $2.88(1.07) = $3.08
Step 3: Calculate the PV of the expected dividends:
PVDiv = $2.40/(1.123) + $2.88/(1.123)2 = $2.14 + $2.28 = $4.42.
Step 4: Calculate P̂2 :
P̂2 = D3/(rs – g) = $3.08/(0.123 – 0.07) = $58.11.
Step 5: Calculate the PV of P̂2 :
PV = $58.11/(1.123)2 = $46.08.
Step 6: Sum the PVs to obtain the stock’s price:
P̂0 = $4.42 + $46.08 = $50.50.
Alternatively, using a financial calculator, input the following:
CF0 = 0, CF1 = 2.40, and CF2 = 60.99 (2.88 + 58.11) and then enter I/YR = 12.3 to solve
for NPV = $50.50.

or in part.
8-6 Value of operations = Vop = PV of expected future free cash flow
FCF (1 + g) $400,000(1.05)
Vop = = = $6,000,000.
WACC − g 0.12 − 0.05
8-7 The growth rate in FCF from 2020 to 2021 is g = ($750.00-$707.55)/$707.50 = 0.06.
$707.55 (1.06)
HV2021 = VOp at 2021 = = $15,000.
0.11 − 0.06
8-8 The problem asks you to determine the constant growth rate, given the following facts: P0
= $80, D1 = $4, and rs = 14%. Use the constant growth rate formula to calculate g:
 D1
rs= +g
P0
$4
0.14 = +g
$80
g = 0.09 = 9%.

or in part.
8-9 The problem asks you to determine the value of P̂3 , given the following facts: D1 = $3, b
= 0.8, rRF = 5.2%, RPM = 6%, and P0 = $40. Proceed as follows:
Step 1: Calculate the required rate of return:
rs = rRF + (rM – rRF)b = 5.2% + (6%)0.8 = 10%.
Step 2: Use the constant growth rate formula to calculate g:
 D1
rs =+g
P0
$3
0.10 = +g
$40
g = 0.025 = 2.5%.
Step 3: Calculate P̂3 :
P̂3 = P0(1 + g)3 = $40(1.025)3 = $43.076 ≈ $43.08.
Alternatively, you could calculate D4 and then use the constant growth rate formula to solve
for P̂3 :
D4 = D1(1 + g)3 = $3.00(1.025)3 = $3.2307.

P̂3 = $3.2307/(0.10 – 0.025) = $43.0756  $43.08.
8-10 Vps = Dps/rps; therefore, rps = Dps/Vps.
a. rps = $3.5/$30 = 11.67%.

b. rps = $3.5/$40 = 8.75%.
c. rps = $3.5/$50 = 7.00%.
d. rps = $3.5/$70 = 5.00%.
D1 D (1 + g) $6[1 + (−0.04)] $5.76

8-11 P̂0 = = 0 = = = $32.00.
rs − g rs − g 0.14 − (−0.04)] 0.18

or in part.
8-12 D0 = $1, rS = 7% + 6% = 13%, g1 = 50%, g2 = 25%, gn = 6%.
0 rs = 13% 1 2 3 4
| | | | |
g1 = 50% g2 = 25% gn = 6%
1.50 1.875 1.9875
1.327 + 28.393 = 1.9875/(0.13 – 0.06)
= 30.268
23.704
$25.03
8-13 Calculate the dividend stream and place them on a time line. Also, calculate the price of
the stock at the end of the nonconstant growth period, and include it, along with the
dividend to be paid at t = 5, as CF5. Then, enter the cash flows as shown on the time line
into the cash flow register, enter the required rate of return as I = 15, and then find the value
of the stock using the NPV calculation. Be sure to enter CF0 = 0, or else your answer will
be incorrect.
D0 = 0; D1 = 0, D2 = 0, D3 = 0.50
D4 = 0.50(1.8) = 0.9; D5 = 0.50(1.8)2 = 1.62; D6 = 0.80(1.8)2(1.07)
= $1.7334.
P̂0 = ?
0 rs = 16% 1 2 3 g = 80%
4 5 g = 7%
6
| | | | | | |
0.50 0.90 1.62 1.7334
0.32 19.26
0.50 20.88 0.16 − 0.07
9.94
$10.76 = P̂0
P̂5 = D6/(rs – g) = 1.7334/(0.16 – 0.07) = 19.26. This is the price of the stock at the end of
Year 5.
CF0 = 0; CF1-2 = 0; CF3 = 0.5; CF4 = 0.9; CF5 = 20.88; I = 16%.
With these cash flows in the CFLO register, press NPV to get the value of the stock today:
NPV = $10.76.

or in part.
D ps $10
8-14 a. Vps = = = $125.
rps 0.08
$10
b. Vps = = $83.33.
0.12
8-15 a. g = $1.1449/$1.07 – 1.0 = 7%.
Calculator solution: Input N = 1, PV = -1.07, PMT = 0, FV = 1.1449,

I/YR = ? I = 7.00%.
b. $1.07/$21.40 = 5%.

c. r s= D1/P0 + g = $1.07/$21.40 + 7% = 5% + 7% = 12%.
$3(1 − 0.05) $2.85

8-16 a. 1. P̂0 = = = $15.83.
0.13 + 0.05 0.18
2. P̂0 = $3/0.13 = $23.08.
$3(1.05) $3.15
3. P̂0 = = = $39.38.
0.13 − 0.05 0.08
$3(1.10) $3.30
4. P̂0 = = = $110.00.
0.13 − 0.10 0.03
b. 1. P̂0 = $3.39/0 = Undefined.
2. P̂0 = $3.45/(-0.02) = -$172.5, which is nonsense.
These results show that the formula does not make sense if the required rate of return
is equal to or less than the expected growth rate.
c. No.

or in part.
$108,000
8-17 a. HV2 = = $2,700,000.
0.12 − 0.08
b. 0 WACC = 12%1 2 g = 8% 3 N
| | | | • • • |
$80,000 $100,000 $108,000
$ 71,428.57
79,719.39
2,152,423.47
$2,303,571.43
$40 (1.07)
8-18 a. HV3 = = $713.33.
0.13 − 0.07
b. 0 1 2 3 4 N
WACC = 13%
| | | | g = 7% | • • • |
-20 30 40
($ 17.70)
23.49 Vop 3 = 713.33
522.10 753.33
$527.89
c. Total valuet=0 = $527.89 + $10.0 = $537.89.

Value of common equity = $537.89 - $100 = $437.89.
$437.89
Price per share = = $43.79.
10.0

or in part.
8-19 0 g=6% 1 2 3 4
| | | | |
D0 = 1.50 D1 D2 D3 D4
P̂3
a. D1 = $1.5(1.06) = $1.59. D2 = $1.50(1.06)2 = $1.69. D3 = $1.5(1.06)3 = $1.79.
b. PV = $1.59(0.8850) + $1.69(0.7831) + $1.79(0.6930) = $3.97.
Calculator solution: Input 0, 1.59, 1.69, and 1.79 into the cash flow register, input I/YR
= 13, PV = ? PV = $3.97.
c. $27.05(0.6930) = $18.74.
Calculator solution: Input 0, 0, 0, and 27.05 into the cash flow register, I/YR = 13, PV
= ? PV = $18.74.
d. $18.74 + $3.97 = $22.71 = Maximum price you should pay for the stock. (rounding
differences may give you $22.72.)
D 0 (1 + g) D1 $1.59
e. P̂0 = = = = $22.71.
rs − g rs − g 0.13 − 0.06
f. The value of the stock is not dependent upon the holding period. The value calculated
in Parts a through d is the value for a 3-year holding period. It is equal to the value
calculated in Part e except for a small rounding error. Any other holding period would
produce the same value of P̂0 ; that is, P̂0 = $22.71.
8-20 a. End of Year: 0 r = 12%1 2 3 4 5 6

| | | | | | |
g = 15% g = 5%
D0 = 1.75 D1 D2 D3 D4 D5 D6
Dt = D0(1 + g)t
D1 = $1.75(1.15)1 = $2.01.
D2 = $1.75(1.15)2 = $1.75(1.3225) = $2.31.
D3 = $1.75(1.15)3 = $1.75(1.5209) = $2.66.
D4 = $1.75(1.15)4 = $1.75(1.7490) = $3.06.
D5 = $1.75(1.15)5 = $1.75(2.0114) = $3.52.

or in part.
b. Step 1
5
D
PV of dividends =  (1 + rt ) t .
t =1 s
PV D1 = $2.01(PVIF12%,1) = $2.01(0.8929) = $1.79
PV D2 = $2.31(PVIF12%,2) = $2.31(0.7972) = $1.84
PV D3 = $2.66(PVIF12%,3) = $2.66(0.7118) = $1.89
PV D4 = $3.06(PVIF12%,4) = $3.06(0.6355) = $1.94
PV D5 = $3.52(PVIF12%,5) = $3.52(0.5674) = $2.00
PV of dividends = $9.46
Step 2
D6 D5 (1 + g n ) $3.52(1.05) $3.70
P̂5 = = = = = $52.80.
rs − g n rs − g n 0.12 − 0.05 0.07
This is the price of the stock 5 years from now. The PV of this price, discounted back
5 years, is as follows:
PV of P̂5 = $52.80(PVIF12%,5) = $52.80(0.5674) = $29.96.

Step 3
The price of the stock today is as follows:
P̂0 = PV dividends Years 1 through 5 + PV of P̂5

= $9.46 + $29.96 = $39.42.
This problem could also be solved by substituting the proper values into the following
equation:
5
5 D 0 (1 + g s ) t  D6  1 
P̂0 =  +     .
t =1 (1 + rs ) t  rs − g n   1 + rs 
Calculator solution: Input 0, 2.01, 2.31, 2.66, 3.06, 56.32 (3.52 + 52.80) into the cash
flow register, input I/YR = 12, PV = ? PV = $39.43.

or in part.
c. First Year (t = 0)
D1/P0 = $2.01/$39.42 = 5.10%
Capital gains yield = 6.90%
Expected total return = 12.00%
Sixth Year (t = 5)
D6/P5 = $3.70/$52.80 = 7.00%
Capital gains yield = 5.00
Expected total return = 12.00%
*We know that r is 12%, and the dividend yield is 5.10%; therefore, the capital gains
yield must be 6.90%.
The main points to note here are as follows:
1. The total yield is always 12% (except for rounding errors).
2. The capital gains yield starts relatively high, then declines as the nonconstant
growth period approaches its end. The dividend yield rises.
3. After t = 5, the stock will grow at a 5% rate. The dividend yield will equal 7%, the
capital gains yield will equal 5%, and the total return will be 12%.

or in part.
8-21 a. Part 1. Graphical representation of the problem:
Nonconstant Normal
growth growth
0 1 2 3 ∞
| | | | |
D0 D1 (D2 + P̂2 ) D3 D∞
PVD1
PVD2
PV P̂2
P0
D1 = D0(1 + gs) = $2.50(1.30) = $3.25.

D2 = D0(1 + gs)2 = $2.50(1.30)2 = $4.225.
D3 D (1 + g n ) $4.225 (1.06)
P̂2 = = 2 = = $90.415.
rs − g n rs − g n 0.12 − 0.07
P̂0 = PV(D1) + PV(D2) + PV( P̂ ) 2
D1 D2 P̂2
= + +
(1 + rs ) (1 + rs ) 2
(1 + rs ) 2
= $3.25(0.8929) + $4.225(0.7972) + $90.415(0.7972) = $78.35.
Calculator solution: Input 0, 3.25, 94.64(4.225 + 90.415) into the cash flow register,
input I/YR = 12, PV = ? PV = $78.35.

or in part.
Part 2.
Expected dividend yield: D1/P0 = $3.25/$78.35 = 4.15%.
Capital gains yield: First, find P̂1 which equals the sum of the present values of D2 and
P̂2 , discounted for one year.
$4.225 + $90.415
P̂1 = D2/(1.12) + P̂2 /(1.12) = = $84.50.
(1.12)1
Calculator solution: Input 0, 94.64 (4.225 + 90.415) into the cash flow register, input
I/YR = 12, PV = ? PV = $84.50.
Second, find the capital gains yield:
P̂1 − P0 $84.50 − $78.35

= = 7.85%.
P0 $78.35
Dividend yield = 4.15%

Capital gains yield = 7.85
12.00% = rs.
b. Due to the longer period of supernormal growth, the value of the stock will be higher
for each year. Although the total return will remain the same, rs = 12%, the distribution
between dividend yield and capital gains yield will differ: The dividend yield will start
off lower and the capital gains yield will start off higher for the 5-year nonconstant
growth condition, relative to the 2-year nonconstant growth state. The dividend yield
will increase and the capital gains yield will decline over the 5-year period until divi-
dend yield = 5% and capital gains yield = 7%.
c. Throughout the nonconstant growth period, the total yield will be 12%, but the dividend
yield is relatively low during the early years of the nonconstant growth period and the
capital gains yield is relatively high. As we near the end of the nonconstant growth
period, the capital gains yield declines and the dividend yield rises. After the
nonconstant growth period has ended, the capital gains yield will equal gn = 7%. The
total yield must equal rs = 12%, so the dividend yield must equal 12% - 7% = 5%.

or in part.
d. Some investors need cash dividends (retired people) while others would prefer growth.
Also, investors must pay taxes each year on the dividends received during the year,
while taxes on capital gains can be delayed until the gain is actually realized.

or in part.
SOLUTION TO SPREADSHEET PROBLEMS
8-22 The detailed solution for the spreadsheet problem, Ch08 P22 Build a Model Solution.xlsx,
is available at the textbook’s Web site.

or in part.
MINI CASE
Your employer, a mid-sized human resources management company, is considering

expansion into related fields, including the acquisition of Temp Force Company, an
employment agency that supplies word processor operators and computer programmers to
businesses with temporary heavy workloads. Your employer is also considering the purchase
of Biggerstaff & McDonald (B&M), a privately held company owned by two friends, each
with 5 million shares of stock. B&M currently has free cash flow of $24 million, which is
expected to grow at a constant rate of 5%. B&M’s financial statements report short-term
investments of $100 million, debt of $200 million, and preferred stock of $50 million. B&M’s
weighted average cost of capital (WACC) is 11%. Answer the following questions.
a. Describe briefly the legal rights and privileges of common stockholders.

Answer: The common stockholders are the owners of a corporation, and as such, they have
certain rights and privileges as described below.
1. Ownership implies control. Thus, a firm’s common stockholders have the right to
elect its firm’s directors, who in turn elect the officers who manage the business.
2. Common stockholders often have the right, called the preemptive right, to purchase
any additional shares sold by the firm. In some states, the preemptive right is
automatically included in every corporate charter; in others, it is necessary to insert
it specifically into the charter.
b. What is free cash flow (FCF)? What is the weighted average cost of capital? What
is the free cash flow valuation model?
Answer: Free cash flow (FCF) is the cash flow available for distribution to all of a company’s
investors. FCF is generated by a company’s operations.
The weighted average cost of capital (WACC) is the overall rate of return required by
all of the company’s investors. The PV of their expected future free cash flows,
discounted at the WACC, is the value of operations. This is the essence of the FCF
valuation model.
Mini Case: 8 - 20
or in part.

FCF
Vop =  (1 + WACC
t
)t
t =1
Nonoperating assets are marketable securities and ownership of non-controlling

interest in another company. The value of nonoperating assets usually is very close to
figure that is reported on balance sheets.
c. Use a pie chart to illustrate the sources that comprise a hypothetical company’s total
value. Using another pie chart, show the claims on a company’s value. How is equity
a residual claim?
Answer: Total corporate value is sum of value of operations and value of nonoperating assets.
Some company’s also have growth options, but assume they are negligible for this
company. Debt holders have first claim. Preferred stockholders have the next claim.
Any remaining value belongs to stockholders.
Mini Case: 8 - 21
or in part.
d. 1. Suppose the free cash flow at Time 1 is expected to grow at a constant rate of g L
forever. If gL < WACC, what is a formula for the present value of expected free
cash flows when discounted at the WACC?
Answer:
FCF1
Vop =
(WACC − g L )
d. 2. If the most recent free cash flow is expected to grow at a constant rate of gL forever
(and gL < WACC), what is a formula for the present value of expected free cash
flows when discounted at the WACC?
Answer:
FCF0 (1 + g L )
Vop =
(WACC − g L )
e. 1. Use B&M’s data and the free cash flow valuation model to answer the following
questions. What is its estimated value of operations?
Answer:
FCF0 (1 + g L )
Vop =
(WACC − g L )
24 (1 + 0.05)
Vop = = 420
(0.11 − 0.05)
e. 2. What is its estimated total corporate value? (This is the entity value.)
Answer: Total corporate value = Vop + Short-term investments.

= $420 + $100
= $520 million
e. 3. What is its estimated intrinsic value of equity?
Answer: Intrinsic value of equity = Total value- Debt - Pref.
Mini Case: 8 - 22
or in part.
= $520 - $200 - $50
= $270 million
e. 4. What is its estimated intrinsic stock price per share?
Answer: Intrinsic stock price per share = Value of equity / Number of shares
= $270 / 10 - $200 - $50
= $27.00
f. 1. You have just learned that B&M has undertaken a major expansion that will
change its expected free cash flows to −$10 million in 1 year, $20 million in 2
years, and $35 million in 3 years. After 3 years, free cash flow will grow at a rate
of 5%. No new debt or preferred stock were added, the investment was financed
by equity from the owners. Assume the WACC is unchanged at 11% and that
there are still 10 million shares of stock outstanding. What is its horizon value (i.e.,
its value of operations at year three)? What is its current value of operations (i.e.,
at time zero)?
Answer:
Year 0 1 2 3 4 5 …t
FCF −$10 $20 $35 FCF3(1+0.05) FCF4(1+ 0.05) FCFt(1+ 0.05)
FCF3 (1 + g L )
HV3 = Vop,3 =
WACC − g L
35 (1 + 0.05)
HV3 = V op,3 = = $612.50
0.11 − 0.05
Mini Case: 8 - 23
or in part.
Year 0 1 2 3 4 5 …t
FCF FCF1 FCF2 FCF3
PV of FCF in explicit forecast ←↵ ←↵ ←↵
FCF3(1+gL) FCF4(1+gL) FCFt(1+gL)

HV3 ←↵ ←↵ ←↵
PV of HV is the PV of FCF beyond ←↵ ←↵ ←↵
the explicit forecast
0 WACC = 11% 1 2 3 gL = 5%
4 N
| | | | | • • • |
-10 20 35
$ -9.009
16.232
25.592
447.855 Vop 3 = 612.5 = 35 (1 + 0.05)
0.11 − 0.05
$480.67 = Value of operations
f. 2. What is its value of equity on a price per share basis?
Answer:
Value of operations $480.67

+ Value of nonoperating assets 100.00
Total estimated value of firm $580.67
− Debt 200.00
− Preferred stock 50.00
Estimated value of equity $330.67
÷ Number of shares 10.00
Estimated stock price per share = $33.07
Mini Case: 8 - 24
or in part.
g. If B&M undertakes the expansion, what percent of B&M’s value of operations at
Year 0 is due to cash flows from Years 4 and beyond? Hint: use the horizon value
at t = 3 to help answer this question.
Answer: First, calculate the present value of the horizon value. Then divide the present value
of the horizon value by the Year 0 value of operations. This will show what percent
of value is due to cash flows occurring 4 or more years in the future.
Vop,0 = $480.67
HV3 = $612.50
PV of HV3 = $612.50/(1+0.11)3 = $447.855
Percent of value due to cash flows from Year 4 and beyond:
% due to long-term = (PV of HV3) / Vop,0 = $447.855 / $480.67 = 0.93 = 93%
h. Based on your answer to the previous question, what are two reasons why
managers often emphasize short-term earnings?
Answer: 1. Changes in quarterly earnings can signal changes future in cash flows. This would
affect the current stock price.
2. Managers often have bonuses tied to quarterly earnings, so they have incentive to
manage earnings.
Mini Case: 8 - 25
or in part.
i. Your employer also is considering the acquisition of Hatfield Medical Supplies.
You have gathered the following data regarding Hatfield, with all dollars reported
in millions: (1) most recent sales of $2,000; (2) most recent total net operating
capital, OpCap = $1,120; (3) most recent operating profitability ratio, OP =
NOPAT/Sales = 4.5%; and (4) most recent capital requirement ratio, CR =
OpCap/Sales = 56%. You estimate that the growth rate in sales from Year 0 to
Year 1 will be 10%, from Year 1 to Year 2 will be 8%, from Year 2 to Year 3 will
be 5%, and from Year 3 to Year 4 will be 5%. You also estimate that the long-
term growth rate beyond Year 4 will be 5%. Assume the operating profitability
and capital requirement ratios will not change. Use this information to forecast
Hatfield's sales, net operating profit after taxes (NOPAT), OpCap, free cash flow,
and return on invested capital (ROIC) for Years 1 through 4. Also estimate the
annual growth in free cash flow for Years 2 through 4. The weighted average cost
of capital (WACC) is 9%. How does the ROIC in Year 4 compare with the
WACC?
Answer:
The operating items are forecast as follows: Sales1 = $2,000(1+0.10) = $2,200;

NOPAT1 = $2,200(0.045) = $99; and OpCap1 = $2,200(0.56) = $1,232. The operating
items for the other years are forecast in a similar manner.
Actual Forecast
Scenario:
No Change 0 1 2 3 4
Sales $2,000 $2,200 $2,376 $2,495 $2,620
NOPAT $99 $107 $112 $117.879
OpCap $1,120 $1,232 $1,331 $1,397.088 $1,466.942
FCF −$13 $8.36 $45.738 $48.025
Growth in FCF -164% 447.1% 5.0%
ROIC 8.0% 8.0% 8.0% 8.0% 8.0%
The ROIC4 is 8% and the WACC is 9%. This means that ROIC < WACC/(1+gL) at
the horizon: 0.08 < 9%/(1 + 0.05) = 0.0857. Therefore, we expect that the value of
operations at Year 4 (i.e., the horizon value at Year 4) should be less than the total net
operating capital at Year 4, OpCap4.
Mini Case: 8 - 26
or in part.
j. What is the horizon value at Year 4? What is the total net operating capital at
Year 4? Which is larger, and what can explain the difference? What is the value
of operations at Year 0? How does the Year-0 value of operations compare with
the Year-0 total net operating capital?
Answer:
FCF4 (1 + g L ) $48.025(1 + 0.05)

HV4 = = = $1,260.65
(WACC − g L ) (0.09 − 0.05)
HV4 $1,260.65
PV of HV4 = (1+WACC) 4 = (1+0.09)4 = $893.08
FCF1 FCF2 FCF3 FCF4
PV of FCF = (1+WACC)1
+ (1+WACC) 2 + (1+WACC)3 + (1+WACC)4
−$13 $8.36 $45.738 $48.025
PV of FCF = (1+0.09)1
+ (1+0.09)2 + (1+0.09)3 + (1+0.09)4
PV of FCF = $64.45
The value of operations is the sum of the PV of the horizon value plus the PVs of the
FCFs:
Value of Operations:
Present value of HV $893.08

+ Present value of FCF $64.45
Value of operations ≈ $958
Notice that the value of operations at Year 4 (i.e., the horizon value, HV4) is $1,260.65
and that the total net operation capital at Year 4 (OpCap4 from Part i) is $1,466.94. In
other words, the value of operations is less than the total net operating capital. This is
because ROIC4 < WACC/(1+gL) at the horizon: 0.08 < 9%/(1 + 0.05) = 0.0857.
Also, at Year 0, the most recent total net operating capital, OpCap0 = $1,120. Note that
the value of operations at Year 0 is $958, and this is less than the OpCap0. Thus, the
low ROIC relative to the WACC causes the value of operations to be less than the total
net operating capital.
Mini Case: 8 - 27
or in part.
k. What are value drivers? What happens to the ROIC and current value of
operations if expected growth increases by 1 percentage point relative to the
original growth rates (including the long-term growth rate)? What can explain
this? Hint: Use Scenario Manager.
Answer: Value drivers are the inputs to the FCF valuation model that managers are able to
influence: sales growth rates, operating profitability, capital requirements, and cost of
capital.
Scenario No Change Improve Growth

g0,1 10% 11%
g1,2 8% 9%
g2,3 5% 6%
g3,4 5% 6%
gL 5% 6%
OP 4.5% 4.5%
CR 56.0% 56.0%
ROIC 8.0% 8.0%
Current value of operations $958 $933
WACC 9.00% 9.00%
WACC/(1+WACC) 8.26% 8.26%
Higher growth causes Vop,0 to fall. ROIC must be greater than WACC/(1+WACC) for
growth to add value.
l. Assume growth rates are at their original levels. What happens to the ROIC and
current value of operations if the operating profitability ratio increases to 5.5%?
Now assume growth rates and operating profitability ratios are at their original
levels. What happens to the ROIC and current value of operations if the capital
requirement ratio decreases to 51%? Assume growth rates are at their original
levels. What is the impact of simultaneous improvements in operating profitability
and capital requirements? What is the impact of simultaneous improvements in
the growth rates, operating profitability, and capital requirements? Hint: Use
Scenario Manager.
Mini Case: 8 - 28
or in part.
Answer: .
Scenario No Change Improve OP

g0,1 10% 10%
g1,2 8% 8%
g2,3 5% 5%
g3,4 5% 5%
gL 5% 5%
OP 4.5% 5.5%
CR 56.0% 56.0%
ROIC 8.0% 9.8%
Current value of operations $958 $1,523
WACC 9.00% 9.00%
WACC/(1+WACC) 8.26% 8.26%
The improvement in operating profitability increases the ROIC, which increases the value of
operations.
Scenario No Change Improve CR

g0,1 10% 10%
g1,2 8% 8%
g2,3 5% 5%
g3,4 5% 5%
gL 5% 5%
OP 4.5% 4.5%
CR 56.0% 51.0%
ROIC 8.0% 8.8%
WACC 9.00% 9.00%
WACC/(1+WACC) 8.26% 8.26%
The improvement in capital requirements increases the ROIC, which increases the value of
operations.
Mini Case: 8 - 29
or in part.
Scenario No Change Improve OP and CR
g0,1 10% 10%
g1,2 8% 8%
g2,3 5% 5%
g3,4 5% 5%
gL 5% 5%
OP 4.5% 5.5%
CR 56.0% 51.0%
ROIC 8.0% 10.8%
WACC 9.00% 9.00%
WACC/(1+WACC) 8.26% 8.26%
The improvements in operating profitability and capital requirements increased the ROIC, so
growth now adds substantial value.
Scenario No Change Improve All

g0,1 10% 11%
g1,2 8% 9%
g2,3 5% 6%
g3,4 5% 6%
gL 5% 6%
OP 4.5% 5.5%
CR 56.0% 51.0%
ROIC 8.0% 10.8%
WACC 9.00% 9.00%
WACC/(1+WACC) 8.26% 8.26%
The improvements in operating profitability increased the ROIC, so growth now adds substantial
value.
Mini Case: 8 - 30
or in part.
m. What insight does the free cash flow valuation model give provide us about
possible reasons for market volatility? Hint: Look at the value of operations for
the combinations of ROIC and gL in the previous questions.
Answer: .
ROIC
gL 8.0% 8.8% 9.8% 10.8%
5% $958 $1,191 $1,523 $1,756
6% $933 $1,247 $1,694 $2,008
Small changes in ROIC and growth cause large changes in value. Similarly, small
changes in the cost of capital (WACC) cause large changes in value. As new
information arrives, investors continually update their estimates of operating
profitability, capital requirements, growth, risk, and interest rates. If stock prices aren’t
volatile, then this means there isn’t a good flow of information
n. 1. Write out a formula that can be used to value any dividend-paying stock,
regardless of its dividend pattern
Answer: The value of any stock is the present value of its expected dividend stream:
D1 D2 D3 D
P̂0 = + + ++ .
(1 + rs ) t (1 + rs ) (1 + rs ) 3 (1 + rs ) 
However, some stocks have dividend growth patterns which allow them to be valued
using short-cut formulas.
Mini Case: 8 - 31
or in part.
n. 2. What is a constant growth stock? How are constant growth stocks valued?
Answer: A constant growth stock is one whose dividends are expected to grow at a constant rate
forever. “Constant growth” means that the best estimate of the future growth rate is
some constant number, not that we really expect growth to be the same each and every
year. Many companies have dividends which are expected to grow steadily into the
foreseeable future, and such companies are valued as constant growth stocks.
For a constant growth stock:
D1 = D0(1 + gL), D2 = D1(1 + gL) = D0(1 + gL)2, and so on.
With this regular dividend pattern, the general stock valuation model can be simplified
to the following very important equation:
D1 D (1 + g L )
P̂0 = = 0 .
rs − g L rs − g L
This is the well-known “Gordon,” or “constant-growth” model for valuing stocks. Here
D1, is the next expected dividend, which is assumed to be paid 1 year from now, rs is
the required rate of return on the stock, and g is the constant growth rate.
n. 3. What happens if a company has a constant gL that exceeds its rs? Will many stocks
have expected growth greater than the required rate of return in the short run
(i.e., for the next few years)? In the long run (i.e., forever)?
Answer: The model is derived mathematically, and the derivation requires that rs > gL. If gL is
greater than rs, the model gives a negative stock price, which is nonsensical. The model
simply cannot be used unless (1) rs > gL, (2) gL is expected to be constant, and (3) gL
can reasonably be expected to continue indefinitely.
Stocks may have periods of nonconstant growth, where g > rs; however, this growth
rate cannot be sustained indefinitely. In the long-run, gL < rs.
Mini Case: 8 - 32
or in part.
o. Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the
yield on T-bonds) is 7%, and that the market risk premium is 5%. What is the
required rate of return on the firm’s stock?
Answer: Here we use the SML to calculate temp force’s required rate of return:
rs = rRF + (rM – rRF)bTemp Force = 7% + (12% – 7%)(1.2)
= 7% + (5%)(1.2) = 7% + 6% = 13%.
p. Assume that Temp Force is a constant growth company whose last dividend (D0,
which was paid yesterday) was $2.00 and whose dividend is expected to grow
indefinitely at a 6% rate.
p. 1. What is the firm’s current stock price?
Answer: We could extend the time line on out forever, find the value of Temp Force’s dividends
for every year on out into the future, and then the PV of each dividend, discounted at r
= 13%. For example, the PV of D1 is $1.76106; the PV of D2 is $1.75973; and so forth.
Note that the dividend payments increase with time, but as long as rs > gL, the present
values decrease with time. If we extended the graph on out forever and then summed
the PVs of the dividends, we would have the value of the stock. However, since the
stock is growing at a constant rate, its value can be estimated using the constant growth
model:
D1
P̂0 =
rs − g L
D1 = D0 (1+gL) = $2.00 (1.06) = $2.12
D1 $2.12 $2.12
P̂0 = = = = $30.29.
rs − g 0.13 − 0.06 0.07
Mini Case: 8 - 33
or in part.
p. 2. What is the stock’s expected value one year from now?
Answer: After one year, D1 will have been paid, so the expected dividend stream will then be
D2, D3, D4, and so on. Thus, the expected value one year from now is $32.10:
D2
P̂1 =
( rs − g L )
D2 = D1 (1+gL) = $2.12(1.06) = 2.2472
D2 $2.2472 $2.2472
P̂1 = = = = $32.10.
( rs − g L ) (0.13 − 0.06) 0.07
Mini Case: 8 - 34
or in part.
p. 3. What are the expected dividend yield, the capital gains yield, and the total return
during the first year?
Answer: The expected dividend yield in any year n is
Dn $2.12
Dividend Yield =
P̂n −1 0.13 − 0.06
D1 $2.12
Expected Dividend Yield at Time 0 = = = 7%
P̂0 $30.29
While the expected capital gains yield is
( P̂n − P̂n −1 )
Capital Gains Yield =
P̂n −1
( P̂n − P̂n −1 ) $32.10 − $30.29 $1.81

Expected Capital Gains Yield at Time 0 = = = = 6%
P̂n −1 $30.29 $30.29
Alternatively,
Capital Gains Yield = rs – Dividend Yield = 13% − 7% = 6%
The total yield is comprised of the dividend yield and the capital gains yield.
Dividend yield = 7.0%
Capital gains yield = 6.0%
Total return = 13.0%
q. Now assume that the stock is currently selling at $30.29. What is its expected rate
of return?
Answer: The constant growth model can be rearranged to this form:
D1
r̂s = +g.
P0
Mini Case: 8 - 35
or in part.
Here the current price of the stock is known, and we solve for the expected return. For
Temp Force:
r̂s = $2.12/$30.29 + 0.060 = 0.070 + 0.060 = 13%.
r. Now assume that Temp Force’s dividend is expected to experience nonconstant

growth of 30% from Year 0 to Year 1, 20% from Year 1 to Year 2, and 10% from
Year 2 to Year 3. After Year 3, dividends will grow at a constant rate of 6%. What
is the stock’s intrinsic value under these conditions? What are the expected
dividend yield and capital gains yield during the first year? What are the expected
dividend yield and capital gains yield during the fourth year (from Year 3 to Year
4)?
Answer: Temp Force is no longer a constant growth stock, so the constant growth model is not
applicable. Note, however, that the stock is expected to become a constant growth
stock in 3 years. Thus, it has a nonconstant growth period followed by constant growth.
The easiest way to value such nonconstant growth stocks is to set the situation up on a
time line as shown below:
0 rs = 13% 1 2 3 4
| | | | |
g = 30% g = 25% g = 15% gL = 6%
2.6000 3.2500 3.7375 3.9618
2.3009
2.5452
2.5903 3.9618
39.2246 P̂3 = $56.5971 =
0.13 − 0.06
46.6610
Simply enter $2 and multiply by (1.30) to get D1 = $2.60; multiply that result by 1.25
to get D2 = $3.25, multiply that result by 1.15 to get D3 = $3.7375 and multiply that
result by 1.06 to get D4 = $3.9618. Then recognize that after year 3, Temp Force
becomes a constant growth stock, and at that point P̂3 can be found using the constant
growth model. P̂3 is the present value as of t = 3 of the dividends in year 4 and beyond.
With the cash flows for D1, D2, D3, and P̂3 shown on the time line, we discount
each value back to year 0, and the sum of these four PVs is the intrinsic value of the
^ = $46.6610 ≈ $46.66.
stock today, P 0
Mini Case: 8 - 36
or in part.
The dividend yield and the capital gains yield are:
$2.600
Dividend yield = = 0.0557 ≈ 5.6%.
$46.66
Capital gains yield = 13.00% - 5.6% = 7.4%.
During the nonconstant growth period, the dividend yields and capital gains yields are
not constant, and the capital gains yield does not equal g. However, after year 3, the
stock becomes a constant growth stock, with gL = capital gains yield = 6.0% and
dividend yield = 13.0% - 6.0% = 7.0%.
s. What is the market multiple method of valuation? What are its strengths and
weaknesses?
Answer: Analysts often use the P/E multiple (the price per share divided by the earnings per
share) or the P/CF multiple (price per share divided by cash flow per share, which is
the earnings per share plus the dividends per share) to value stocks. For example,
estimate the average P/E ratio of comparable firms. This is the P/E multiple. Multiply
this average P/E ratio by the expected earnings of the company to estimate its stock
price. The entity value (V) is the market value of equity (# shares of stock multiplied
by the price per share) plus the value of debt. Pick a measure, such as EBITDA, sales,
customers, eyeballs, etc. Calculate the average entity ratio for a sample of comparable
firms. For example, V/EBITDA, V/customers. Then find the entity value of the firm in
question. For example, multiply the firm’s sales by the V/sales multiple, or multiply
the firm’s # of customers by the V/customers ratio. The result is the total value of the
firm. Subtract the firm’s debt to get the total value of equity. Divide by the number of
shares to get the price per share. There are problems with market multiple analysis. (1)
It is often hard to find comparable firms. (2) The average ratio for the sample of
comparable firms often has a wide range. For example, the average P/E ratio might be
20, but the range could be from 10 to 50. How do you know whether your firm should
be compared to the low, average, or high performers?
Mini Case: 8 - 37
or in part.
t. What are the advantages of the free cash flow valuation model relative to the
dividend growth model?
Answer: You can apply FCF model in more situations, such as privately held companies,
divisions of companies, and companies that pay zero (or very low) dividends. However,
the FCF model requires forecasted financial statements to estimate FCF.
u. What is preferred stock? Suppose a share of preferred stock pays a dividend of

$2.10 and investors require a return of 7%. What is the estimated value of the
preferred stock?
D ps $2.10
Answer: Vps = = = $30.00
rps 0.07
Mini Case: 8 - 38
or in part.
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Nestle Cove post-office, no one claimed the dog. When Mr. Horton
came down the next Saturday and took them all out driving, Curly
perched on Sunny’s lap in the front seat and very plainly enjoyed the
trip.
“He’s used to riding in a car,” said Mr. Horton. “I wonder why no
one advertises for him or tries to find him.”
“Maybe I can keep him always,” said Sunny hopefully. “He can sit
up, Daddy, and beg, and play dead. I think he’s a very educated
dog.”
CHAPTER XII
SUNNY BOY IS NAUGHTY
C URLY proved to be a happy-natured little dog, and was soon a

great favorite with all the children who played on the beach.
“I wish I had one just like him,” said Ellen.
“I’d rather have a bigger dog,” said Ralph. “One, maybe, as big as
Queen.”
“Oh,” declared Sunny Boy, “no other dog could be as nice as
Curly! Though Queen is nice, too, and I like her awful much,” he
added, feeling that if Queen could know what he had just said her
feelings might be hurt.
At first Sunny Boy had an uneasy feeling that the dog might be
claimed any day, but as two weeks went by and no one came to look
for a lost bow-wow, this feeling gradually vanished entirely. “Curly”
was, in Sunny’s mind, his own dog.
“I wish I had something to do,” sighed Sunny Boy one warm
morning.
“Find Ellen and Ralph and play with them,” suggested Mrs. Horton
promptly. She was sitting in the porch swing, mending. Aunt Bessie
and Miss Martinson had gone up to the city to shop.
“Their father took ’em sailing,” Sunny Boy explained
disconsolately, referring to Ellen and Ralph. “I wish Daddy stayed
here all the time. We could go fishing, too.”
“Well, you know what Daddy would say if he were here about little
boys who are always wishing for what they have not,” said Mrs.
Horton, rummaging in her stocking bag for tan cotton to darn a huge
hole in one of Sunny’s socks. “You’ve ever so many pleasant things
to do, dear. Don’t sit there and grumble.”
“I can’t do anything at all!” Sunny Boy was in a perverse mood. “I
can’t go swimming, ’less some one is there watching me. And I can’t
drive the car, ’cause nobody will teach me. An’ you sew all the time
and don’t ’muse me at all!”
Sunny Boy felt so sorry for himself that two big tears ran out of his
blue eyes and splashed down on Curly, asleep in his lap.
“Why Arthur Horton!” Mother’s voice was gentle. “That doesn’t
sound like my little Sunny Boy. Who ever heard of amusing a laddie
with a dog to romp with and the whole beautiful seashore for a
playground? You and Curly run down to the beach now, and see if
you can’t find some more of those shells Aunt Bessie is saving to
make into souvenirs. And this afternoon we’ll go to meet their train
with the car.”
“I don’t want to hunt shells,” grumbled Sunny Boy, kicking his feet
against the step.
“You’ll have to go to your room and stay till lunch time if you can’t
find something pleasant to do,” said Mrs. Horton, firmly. She did not
look at Sunny Boy at all, but at her darning.
Sunny Boy felt as cross as two sticks. He didn’t know why, and
perhaps there wasn’t any reason. If you had asked him, he would
have said that every one was mean to him.
Mother continued to sew steadily. Suddenly a mischievous idea
popped into Sunny’s mind. He put down Curly and ran to his own
room. When he came out he went out of the house the back way,
and slammed the screen-door without speaking to Harriet, who was
busy ironing. You know, don’t you, how it does relieve your feelings
to slam doors? Well, Sunny Boy, who was really as bad as he could
be that morning, felt better directly. He even tried to whistle as he
went down the street.
He knew exactly what he was going to do. He was going to town
and ride on the merry-go-round and have an ice-cream cone. They
had been in Nestle Cove over three weeks, and he had been to town
only that once with Harriet.
“All the other children go,” Sunny Boy said to himself, hailing the
rattling old jitney as it came past the corner. He had taken good care
to walk two blocks down the road so that no one from his house
could see him.
He had a pocketful of pennies that jingled merrily. Daddy on his
last visit had added to the store in the pasteboard box that stood on
Sunny’s bureau, and Mother and the aunties often dropped pennies
in, too. Sunny Boy was sure he had enough money to go to the city
with, had he wished to go.
“Goin’ far?” the jitney driver asked. There were only three other
passengers in his bus.
“To town,” Sunny assured him cheerfully. “Is the merry-go-round
running yet?”
“Well, ’tis, if it didn’t burn down last night,” said the jitney driver. “I
was over that way ’bout ten o’clock, and she sure was crowded.”
The jitney bus went only as far as the post-office, and Sunny paid
his fare there, counting out the five pennies slowly, and jumped
down. He remembered where the merry-go-round was, and if he had
not, the music would have led him to it.
“What are you going on?” asked a boy slightly older than Sunny,
as they stood watching the whirling figures and waiting for the thing
to stop. “I’ve been on everything ’cept the tigers, an’ this time I’m
going on one of ’em.”
“I’d like a zebra,” announced Sunny Boy shyly. “Or maybe a horse
—they go up and down, don’t they?”
“Well, if you’ve money enough, buy two tickets and you can stay
right on for two rides,” advised his new friend. “Let’s see. Oh, yes,
you can buy two. More than two at a time is apt to make you dizzy.
Look, she’s going to stop!”
The merry-go-round did stop with a dismal groan, and Sunny Boy
scrambled on with a crowd of eager children. Most of them had
mothers or older brothers and sisters with them, and when the
attendant came to Sunny Boy and lifted him up, he seemed inclined
to stay there and hold him on.
“I won’t fall off,” urged Sunny with dignity.
“Then you’ll have to be strapped on,” said the man, smiling. “Can’t
have you flying into space when your frisky steed gets to going, you
know. There! now you’re safe, and no one will notice that belt.”
Sunny Boy’s horse went up and down—in time to the
music
Page 161
After the first ride the man came and unbuckled the belt, and,
when Sunny Boy showed his second ticket, lifted him down and up
again on a cream-colored horse. He fastened the belt snugly about
him, and the merry-go-round started gayly. Sunny Boy’s horse went
up and down—in time to the music it seemed to him—and he was
very happy.
When the music stopped and the platform was still, the attendant
came and lifted him down. The floor wobbled under Sunny Boy’s feet
and he felt a bit shaky, but as he walked away he was all right again.
Across the street from the merry-go-round was a large open booth
where soda water was sold. There were people sitting at all four
sides of the fountain and a handsome motor car was drawn up at the
curb before it.
“I’ll get chocolate, with ice-cream,” Sunny Boy decided, jingling his
remaining pennies.
He climbed up, with some difficulty, on one of the high stools, and
gave his order. The white-jacketed boy back of the counter brought it
to him, and with it a pale green check.
“Good, isn’t it?” smiled the white-haired lady who sat next to
Sunny Boy, as he took the first spoonful.
Sunny nodded and smiled, not knowing just what to say.
He had half finished when the boy in the white jacket came back to
him.
“Fifteen cents, please,” he said politely.
Sunny Boy put his hand in his pocket and brought out a little heap
of pennies. He pushed them toward the green check.
“Only eleven cents here,” said the boy impatiently. “Four cents
more, please.”
Sunny Boy looked at him silently, clutching his soda glass tightly
with both hands.
“What is it, dear?” asked the white-haired lady, who was pulling on
her gloves, having finished her soda water. “Haven’t you enough
money?”
Sunny’s lower lip trembled. He shook his head. There was a big
lump in his throat, and he couldn’t have spoken had he tried.
“How much is it? I’ll pay for it,” said the lady, fumbling in her purse.
“Give the child his pennies, and take the check out of this.” She
pushed a bill toward the boy.
“Now drink your soda, dear,” she went on kindly. “Do you live here
in the town?”
“He lives over in the summer colony,” volunteered the boy, bringing
back the change. “My father’s postmaster and he knows every one. I
don’t believe his folks know he’s over here alone. Do they, Buddy?”
Sunny Boy put down his spoon and got off the stool. He didn’t like
to be called buddy, and he had just remembered that his mother
didn’t know where he was. She would worry if he was not home at
lunch time.
“Take your money, kid,” said the boy, who really meant to be kind.
“How are you going to pay jitney fare without a cent in your pocket?
Here, take it.”
Sunny Boy thrust the pennies back in his pocket.
“Thank you very much,” he said to the white-haired lady. “I think
perhaps my mother wants me now.”
The soda fountain boy laughed, but the lady did not. She was very
sweet and serious.
“I wish you’d let me take you home in my car,” she suggested,
quite as one friend to another. “You may have to wait for a jitney
fifteen or twenty minutes, and my chauffeur can have you home in
less time than that. What do you say?”
Sunny Boy nodded, and they got into the beautiful pale gray car,
the tall young chauffeur holding open the door for them. He wore a
gray uniform and the light linen robe he spread over them was gray,
too.
“Curly has hair just like yours,” said Sunny Boy suddenly. He had
been studying the white-haired lady, and he paid her the biggest
compliment he could. He thought Curly’s silky white hair very lovely.
The lady smiled.
“Who is Curly?” she asked.
Sunny Boy told her about the little dog he had found in the storm,
how pretty it was, and how many tricks it could do. The white-haired
lady sat up straighter and straighter, and the prettiest pink came into
her cheeks under her gray veil.
“Carlton, do you hear?” she cried to the chauffeur. “I believe this
child has found Bon-Bon!”
“Bon-Bon?” echoed Sunny Boy, bewildered.
“Yes, Bon-Bon, my dear little dog. My son brought him to me from
France. Is he very tiny, with a sharp little black nose and slim feet? I
thought so! Why you don’t know how glad I am! And to think you’ve
been taking such wonderful care of him all this time!” The white-
haired lady threw her arms around Sunny Boy and hugged him
tightly.
“There he is now,” said the chauffeur, stopping the car before the
Horton bungalow.
Curly, or Bon-Bon as the lady called him, sat on the top step of the
porch, watching them.
CHAPTER XIII
CURLY IS FOUND
T HE white-haired lady was out of the car the instant it stopped

and up the walk, her silk skirts flying in the wind.
“Bon-Bon! Bon-Bon!” she called. Then she said something that
Sunny Boy could not understand. Afterward she told him that it was
French for “Littlest one.”
Curly leaped upon her, barking madly.
The lady took him in her arms and sat down on the step, and, to
Sunny Boy’s amazement, began to cry.
The noise of the dog’s barking brought Mrs. Horton to the door.
“Why, Sunny Boy, where in the world have you been?” she said
quickly. “It’s almost one o’clock. Harriet was just going down to the
beach to look for you.”
Then she saw the strange car at the curb and the strange lady on
her doorstep. The lady stood up and held out her hand.
“I am Mrs. Raymond,” she said. “Colonel Francis Raymond’s wife.
I believe my husband has met Mr. Horton. And now I find your little
boy has found my pet dog.”
Mrs. Horton was very much surprised and greatly pleased to learn
that at last Curly’s own people had been found. She asked Mrs.
Raymond to come in and stay to lunch with them, but Mrs. Raymond
had an appointment at two o’clock several miles away with the
colonel, and lunch would be ready there for the white-haired lady.
She and Mrs. Horton talked very fast, and Sunny Boy could not
understand all they said.
“We advertised and put up a bulletin notice,” he heard Mother say,
“and we couldn’t understand why no one claimed the dog. It was so
evidently a pet, that we knew it couldn’t have been abandoned, and
though exhausted by the storm, it seemed so well-fed we were sure
it had not been lost very long.”
“I lost him the same day you found him,” explained Mrs. Raymond.
“Carlton, the chauffeur, was taking the car up to Draper Inlet to get
my husband. That’s twenty miles up the coast from our cottage, and
Bon-Bon loves so to ride that he never misses a chance to go in the
car. He rode in the back and the hood was down and I suppose he
was on top of that, as he often was. Carlton was trying to make the
inlet before the storm, and I imagine he drove at a pretty hard pace.
Bon-Bon was evidently jolted out going through Nestle Cove, and
neither my husband nor Carlton thought of the dog again till they
reached home and I asked for him.”
“And of course you didn’t know where he was lost,” said Mrs.
Horton sympathetically.
“No, though my husband and Carlton hunted and hunted. But now
everything is all right again. Sunny Boy has made me very happy!”
Mrs. Horton walked with her guest toward the door.
“But what I don’t understand yet,” she said, puzzled, “is how you
met Sunny Boy and he mentioned the dog. Were you out
searching?”
Sunny’s face got very red.
“No, I’d simply stopped in town to get a cool soda before going on
to meet Colonel Raymond,” said Mrs. Raymond. “I think Sunny Boy
had better tell you all about it. Kiss me good-by, dear. I’m going to
send you the very nicest thing I can buy in the city for being so good
to my dog. You won’t feel too bad if I take him away now, will you,
Sunny Boy?”
“No, I—I guess not,” quavered Sunny Boy uncertainly.
He kissed Mrs. Raymond, and gave Bon-Bon, for we might as well
call the dog by its right name now that we know it, a big hug. Then
he sat down on the top step while Mrs. Horton walked with Bon-
Bon’s owner to the car. They stood there several minutes, talking,
and then Mrs. Raymond got in and drove away.
Mrs. Horton came up the path, but Sunny Boy did not look at her.
He was studying a crack in the step with great interest.
“Lunch is on the table, Mrs. Horton,” announced Harriet. “Most
everything’s spoiled, it’s so late.”
“I’m ever so sorry, Harriet, but it couldn’t be helped this time,”
answered Sunny’s mother pleasantly. “Sunny Boy, I want you to go
to your room. Harriet will bring you a bowl of bread and milk, and
when you have eaten that I’m coming in to talk to you.”
Sunny Boy went slowly to his room. When Harriet brought the
bread and milk, he ate it. In perhaps half an hour his mother came
into the room, closing the door quietly.
She drew a low rocking chair near the window where Sunny Boy
stood looking out, and, sitting down, put her arm about him.
“Now tell Mother all about it,” she said, gently turning Sunny Boy
around so that he faced her.
“I wanted to go on the merry-go-round,” explained Sunny Boy,
tracing with his forefinger the outline of one of the pink roses that
grew on Mother’s pretty white dress.
“Well?”
“So I went to town—” Sunny Boy began on another rose.
“And you didn’t ask me? Did you run away, Sunny Boy?”
Sunny Boy was very uncomfortable. His throat didn’t feel right.
And he couldn’t look at his own dear mother, though usually he loved
to watch her face. He wasn’t a Sunny Boy just now.
“Did you run away, Arthur?” she asked again.
Sunny Boy nodded miserably, still fingering the pink roses.
Mrs. Horton did not say anything for a moment. She seemed to be
thinking. Then she gathered both of Sunny Boy’s small hands in her
smooth, soft right hand, keeping her left arm around him.
“Listen to Mother carefully, dear,” she said firmly. “This all
happened because you were cross. Any other morning you would
have found something pleasant to do. But when a little boy makes up
his mind to be cross and not to be pleased with anything he usually
winds up by doing something naughty.”
Two big tears fell out of Sunny Boy’s eyes and rolled down his
cheeks. He was very unhappy.
“What do you suppose Daddy would say,” continued his mother, “if
he knew you had gone over to town without saying a word to me? I
think he would say that he was surprised and grieved to learn that
his only son couldn’t be trusted. Because that is what it really means
—that Daddy and Mother can not trust a little boy who, just because
the day doesn’t go to suit him, runs away and lets his mother worry
about him.”
Sunny Boy put his yellow head down in Mother’s lap and cried as
though his heart would break.
“Don’t you really trust me, Mother?” he managed to sob out.
Mother’s soft arms drew him into her lap.
“Well, yes, I do,” she admitted, smoothing his hair. “Because, you
see, dear, I think you are sorry and will not do it again. Being sorry
makes all the difference in the world.”
Sunny Boy sat up, and this time he found he could look right into
Mother’s deep brown eyes.
“I’m sorry—honest,” he told the little boy he saw there.
“All right, I believe you,” Mother assured him promptly. “I think you
will have to stay here in your room till supper time to help you
remember not to be cross again, and after that we’ll forget about it.
Now tell Mother what you did over in town.”
Sunny Boy told her all about his trip, from the jitney and merry-go-
round rides to his experience at the soda fountain where kind Mrs.
Raymond had paid for his soda-water.
“An’ wasn’t it funny Curly was her dog?” he wound up.
“Yes, indeed,” agreed Mother. “I’m glad the dog found his mistress.
There, I hear the clock striking three. I must go to the station to meet
Aunt Bessie and Miss Martinson.”
“I s’pect they’ll wonder where I am,” said Sunny Boy sadly.
“They probably will,” sighed Mother. “Never mind, Son, just
remember you are never going to run away again.”
And Sunny Boy did remember.
“Why did Mrs. Raymond cry when she found Curly?” he asked, as
Mrs. Horton turned to leave the room. “Did her little boy die in the
war?”
“No, dear,” answered Mrs. Horton. “He came home from France
and brought his mother the dog you call Curly and she calls Bon-
Bon. But her son—he was a Captain—lived only a few months after
he landed in this country; he was invalided home. So, you see, poor
little Bon-Bon means a great deal to Mrs. Raymond because her boy
thought to bring him all the way from France to his mother.”
After Mother had gone—Sunny Boy heard the noise of the car as it
started for the station, though his room was on the wrong side of the
house to see the garage—he thought a great deal about the little lost
dog and the brave soldier who had brought it home to his mother.
The more he thought, the gladder Sunny Boy was to know that Mrs.
Raymond had her dog again.
Two or three days later he was sitting on the front porch waiting for
Aunt Bessie to go swimming with him (Sunny Boy could really swim
very nicely now) when the parcel-post wagon drew up before the
house. The driver grinned as Sunny Boy came flying down the path.
“Package for Arthur Bradford Horton,” he announced cheerfully. “Is
that the little boy who lives next door?”
“Course not!” Sunny Boy was startled at the idea that his package
might go to the boy next door. “That’s my name. Is there something
for me?”
“Looks like it,” admitted the man. “Here you, don’t get under the
horse’s feet, I’m handing it to you as fast as I can. There you are.
Like Christmas, isn’t it?”
Sunny Boy took his package and said “thank you.” It was a large
package, and he wondered what could be in it and who had sent it to
him.
“Maybe it’s from Grandpa,” he told his mother, as she and Aunt
Bessie came out on the porch.
CHAPTER XIV
LOST ON THE OCEAN
“P ERHAPS he has sent you some fresh eggs from the farm,”
teased Aunt Bessie.
“Or a pound of fresh, sweet butter,” suggested Miss Martinson,
coming out on her way to the bathhouse.
“Open it, precious, and see,” urged Mrs. Horton.
So Sunny Boy sat down and carefully untied the red cord and took
off the wrapping paper. There was a pasteboard box tied with more
string to be opened then.
“Why—why—” Sunny Boy, peeping down under the tissue paper
that packed this box, uttered a shriek of delight.
“Look, Mother!” he shouted. “It’s a boat!”
It was a boat, sure enough—a beautiful boat with three sails and
two decks and a large American flag in her bow. Her name was
painted on her sides in bright blue letters—The Billow.
Sunny Boy was delighted.
“Did Grandpa send it?” he asked, his eyes big with surprise.
“I hardly think so,” smiled Mrs. Horton. “See, dear, here is a card
that dropped out. Shall I read it to you? ‘To Sunny Boy, with love
from Mrs. Raymond and Bon-Bon.’ Mrs. Raymond sent it to you,
precious.”
Sunny Boy, of course, wanted to sail his boat immediately. Ellen
and Ralph—Stephen had gone home—who came over presently
thought it was the finest boat they had ever seen. Ralph had one or
two boats, but none as large as The Billow.
“You can sail her sometimes,” offered Sunny Boy. “You get your
Frolic now and let’s go down to the beach and play with ’em. I’ve got
my bathing suit on.”
“If you chickens are going to sail boats, you’ll have to keep away
from the bathing beach,” announced Aunt Bessie decidedly. “You
can’t sail boats in a surf, anyway. Go over on the other side of the
Cove where it is shallow and smoother.”
So the three children, the two boys carrying their boats, marched
over to the side of the Cove where a small fleet of rowboats were
kept at anchor and where the only house in sight was a small shanty
where an old fisherman lived who made his living by selling tackle
and bait.
“Guess Mr. Grimes has taken out a fishing party to-day,” said
Ralph, noticing that the shanty door was closed. “His boat’s gone,
too. Come on now, Sunny, let’s see The Billow race the Frolic.”
The Billow rested lightly on the water, and as there was hardly a
breath of wind, Sunny Boy had to tow her instead of letting her sails
carry her. But towing your boat on a warm summer’s day when you
have your bathing suit on and are not afraid of getting wet, is great
fun.
“If there was any wind, I guess your boat could beat mine,”
conceded Ralph generously. “But if we can’t sail ’em, let’s play taking
fishing parties out.”
“How?” asked Sunny Boy practically.
“Well, we have to have some people—make-believe, of course,”
answered Ralph. “An’ then we ought to have something to eat.”
“Ellen’s paper dolls would do for people,” said Sunny Boy. “We’ll
ask her if she’ll go an’ get ’em. And I’ll go and ask Harriet for
something to eat.”
“All right,” agreed Ralph. “I’ll hold the boats till you come back. Hi,
Ellen!” he called to his little sister. “Want to give your paper dolls a
sail?”
Ellen was willing, when she understood what the boys wanted,
and she trotted up the beach with Sunny Boy to fetch the paper doll
family. At the corner they parted, Sunny Boy to ask Harriet for a
“piece of picnic,” as he said.
“Something to eat?” repeated Harriet in pretended surprise. “Why,
Sunny Boy! Weren’t you here for breakfast? Well, I suppose if you
are going to take a sailing party out, you’ll have to see that they are
fed. How will three of these sandwiches I’m making for supper to-
night do? And three chocolate cup cakes? All right, here you are—
and mind you bring home a fish.”
Ellen came flying down the street with her paper dolls as Sunny
Boy started with his food, and though she eyed the delicious little
cakes hungrily, she waited politely till they had joined Ralph on the
beach.
“Oh, my!” said Ellen’s brother, when he saw what Sunny Boy had
brought. “Gee, I’m hungry! Let’s eat before we take our sailing
parties out, Sunny.”
This suited Sunny Boy, and as Ellen made no objection, the three
children sat down comfortably in the sand and ate every crumb of
Harriet’s goodies.
“And now,” announced Ellen, rising and shaking the short skirt of
her bathing suit free of sand, “Mr. and Mrs. Smith and the seven
Smith children want to go fishing for whitebait.”
This large Smith family were Ellen’s best paper dolls, cut from the
colored fashion plates, and though, as Sunny Boy sensibly said, they
were not exactly dressed for a fishing trip, still they did look as
though they were pleased at such a prospect. Mrs. Smith wore a red
velvet suit and a feathered hat, and her husband was in full evening
dress; three of the girls had silver and gold dresses, two of them
wore skating costumes, and the one boy was wearing his bathrobe.
Ralph said he probably had his bathing suit on underneath, and we’ll
hope he had.
“Let the younger children go on Ralph’s boat,” suggested Ellen,
“and Mr. and Mrs. Smith and their son can go with Sunny Boy.”
She arranged them all neatly, weighted them down with shells so
they would not blow away, and the two boys set off, towing the
boats.
But when they came back from the first trip, there was trouble at
once.
“Where’s Mr. Smith?” demanded Ellen, counting her dolls as soon
as the ships were steadied in the sand.
“Mr. Smith?” echoed Sunny Boy helplessly. “Why—why—isn’t he
there?”
“He isn’t here,” said Ellen coldly. “And the shell that held him down
isn’t here. And, Ralph, where is Lucile?”
Lucile was one of the paper dolls who wore a silver frock.
“Gee! I suppose they’re washed away,” admitted Ralph. “I’m
awfully sorry, honest, Ellen. Sunny and I were watching a boat ’way
out, and we didn’t look back at our ships. I’ll ask Mother to let you
have the new fashion magazine to-night.”
“Well, Mr. Smith was torn in one place,” said Ellen kindly. “And I
never did care so much for Lucile. Daddy always called her cross-
eyed. So you needn’t care, Ralph.”
“What’ll we do now?” asked Ralph, tired of the responsibility of
taking paper dolls sailing. A fellow couldn’t be expected to keep the
silly things from blowing away. “What’ll we do now, Sunny?”
“Yes, what’ll we do, Sunny?” chimed in Ellen.
Sunny Boy could usually be counted on to think of some game. He
played alone so much, and, having no sister or brother, often had to
depend upon himself for amusement.
“We’ll play dry-dock,” he suggested now. “Put our ships up for
repairs, you know. Come on, Ellen, you can help build the dry-dock.”
Sunny Boy had seen pictures of the great dry-docks where ships
were sent to be repaired and painted, and he really had a very clear
idea of how they were used. Naturally, he wasn’t so sure how they
were built, but together he and Ralph and Ellen made an
arrangement of sticks that looked very imposing, and into which they
fitted the Frolic and The Billow with some difficulty.
“I think we’ll take ’em out for another sail,” said Sunny Boy, after
the dry-dock was pronounced finished. “And perhaps we’ll have a
wreck. You stay on shore and signal to us, Ellen.”
“Then we’ll come in and go into dry-dock for repairs! That will be
fun,” agreed Ralph. “Come on, let’s have a big wreck.”
But before they could have a wreck, Ellen called them.
“Look what I’ve found!” she cried.
The boys waded back and tied their ships to a cable that held a
half-sunken scow. Ellen had captured a butterfly, yellow with black
spots, and they watched it flutter its beautiful wings in her hands. It
didn’t seem to want to fly away.
“Perhaps he is a tame butterfly,” suggested Sunny Boy. “Let’s give
him a sail on The Billow.”
He straightened up and looked out to where he had left his boat,
gently rocking on the water. Only Ralph’s Frolic was still tied, and
The Billow was drifting out to sea.
“Ralph!” gasped Sunny Boy. “Look! My boat’s untied!”
He waded into the water, but Ralph, splashing after him, caught
him by his shirt.
“It’s deep out there—the beach goes down,” Ralph explained. “You
can’t catch it, Sunny Boy.”
“Daddy’s coming down to-day and I wanted to show it to him,”
Sunny Boy almost sobbed. “I just have to get it, Ralph. I know! I’ll
row after it. Come on, we’ll take this boat.”
Sunny Boy began to untie the rope that fastened one of the
rowboats.
“Don’t you go, Ralph,” ordered his little sister. “You know Mother
wouldn’t like it. Sunny Boy, you won’t catch your boat, an’ maybe
you’ll be drowned.”
“Won’t neither,” retorted Sunny Boy ungraciously, working at the
stiff rope. “Nobody gets drowned in rowboats—so there!”

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13th Edition Brigham Solutions Manual

Intermediate Financial Management 13th Edition Brigham

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Intermediate Financial Management 11th Edition Brigham

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Answers and Solutions: 8- 1

Nonoperating assets include investments in marketable securities and non-

Answers and Solutions: 8 - 2

Answers and Solutions: 8- 3

Answers and Solutions: 8 - 4

Answers and Solutions: 8- 5

8-1 D0 = $1.50; g1-3 = 5%; gn = 10%; D1 through D5 = ?

D1 = D0(1 + g1) = $1.50(1.05) = $1.5750.

8-2 D1 = $1.50; g = 6%; rs = 13%; P̂0 = ?

P̂1 = P0(1 + g) = $22(1.10) = $24.20.

8-4 Dps = $5.00; Vps = $50; rps = ?

Answers and Solutions: 8 - 6

rs = rRF + (rM - rRF)b = 7.5% + (4%)1.2 = 12.3%.

Step 2: Calculate the expected dividends:

Step 3: Calculate the PV of the expected dividends:

PVDiv = $2.40/(1.123) + $2.88/(1.123)2 = $2.14 + $2.28 = $4.42.

Step 4: Calculate P̂2 :

P̂2 = D3/(rs – g) = $3.08/(0.123 – 0.07) = $58.11.

Step 5: Calculate the PV of P̂2 :

Step 6: Sum the PVs to obtain the stock’s price:

P̂0 = $4.42 + $46.08 = $50.50.

Alternatively, using a financial calculator, input the following:

Answers and Solutions: 8- 7

Answers and Solutions: 8 - 8

Step 1: Calculate the required rate of return:

rs = rRF + (rM – rRF)b = 5.2% + (6%)0.8 = 10%.

Step 2: Use the constant growth rate formula to calculate g:

Step 3: Calculate P̂3 :

P̂3 = P0(1 + g)3 = $40(1.025)3 = $43.076 ≈ $43.08.

D4 = D1(1 + g)3 = $3.00(1.025)3 = $3.2307.

8-10 Vps = Dps/rps; therefore, rps = Dps/Vps.

a. rps = $3.5/$30 = 11.67%.

D1 D (1 + g) $6[1 + (−0.04)] $5.76

Answers and Solutions: 8- 9

CF0 = 0; CF1-2 = 0; CF3 = 0.5; CF4 = 0.9; CF5 = 20.88; I = 16%.

Answers and Solutions: 8 - 10

8-15 a. g = $1.1449/$1.07 – 1.0 = 7%.

Calculator solution: Input N = 1, PV = -1.07, PMT = 0, FV = 1.1449,

$3(1 − 0.05) $2.85

2. P̂0 = $3/0.13 = $23.08.

b. 1. P̂0 = $3.39/0 = Undefined.

2. P̂0 = $3.45/(-0.02) = -$172.5, which is nonsense.

Answers and Solutions: 8- 11

c. Total valuet=0 = $527.89 + $10.0 = $537.89.

Answers and Solutions: 8 - 12

a. D1 = $1.5(1.06) = $1.59. D2 = $1.50(1.06)2 = $1.69. D3 = $1.5(1.06)3 = $1.79.

b. PV = $1.59(0.8850) + $1.69(0.7831) + $1.79(0.6930) = $3.97.

8-20 a. End of Year: 0 r = 12%1 2 3 4 5 6

Answers and Solutions: 8- 13