Question

1. General Foods is forecasted to have a beta (measure of market risk) of 1 next year. The risk free rate over the next year is expected to be 1%. The return on the market is expected to be 8%. What is the required return of General Foods based on the firms market risk, calculate the return using the capital asset pricing model? (Similar to part c in the case and this material is covered in chapter 8 on pages 282-287). Write your answer as a decimal.

2. What price would you expect to pay for a stock with a 17.4% required rate of return, 4% rate of dividend growth, and an annual dividend of $2.5 which will be paid next year?

3. What is the dividend next year for a stock that currently pays a $2 dividend which is growing at 6%?

4. Suppose General Foods has decided to enter the soda business and they will require additional capital. Management will finance the project by borrowing $100 million and by halting dividend payments. Management forecasts that free cash flow for the next two years will be -$50, and $35 million. After year 2 the cash flows will grow at a rate of 4%. The current WACC for General foods is 6%. What is the firms price per share given there are 50 Million Shares outstanding?

5. What is the expected rate of return for a stock that is expected to pay $1 dividend next year and is currently selling for $10.  The price of the stock next year is expected to be $10.6. Write your answer as a decimal (i.e. do not change to a percent). So if the answer is 5.2% write the decimal equivalent of 0.052).

Answer 1

Solution 1
	Beta	1
	Risk free rate	1%
	Market rate	8%
	Estimated return=	Risk free rate + Beta * (Market rate - Risk free rate)
	Estimated return=	1%+1*(8%-1%)
	Estimated return=	8.00%
	Estimated return=	0.080
Solution 2
	Required return	17.40%
	Growth rate	4%
	Next dividend	$     2.50
	Share price=	Next dividend/(Return - Growth)
	Share price=	2.50/(17.40%-4%)
	Share price=	$   18.66
Solution 3
	Current dividend	$     2.00
	Growth rate	6%
	Next dividend	2*(1+6%)
	Next dividend	$     2.12
Solution 5
	Current share price	$   10.00
	Next year price	$   10.60
	Next dividend	$     1.00
	Return available=	Dividend+(Share price after year - Share price in beginning)/Share price in beginning
	Return available=	(1+(10.60-10))/10
	Return available=	16%
	Return available=	0.16

Solution 4:

Year			Cash flow	PV factor @6%, 1/(1+r)^time	Cashflow * PV factor
1			$    (50.00)	0.9434	$    (47.17)
2			$     35.00	0.8900	$      31.15
2			$1,820.00	0.8900	$ 1,619.79
				Current value	$ 1,603.77
Current Cash flow	$       35.00
Rate of return	6.00%
Growth Rate	4.00%
Share Price at the horizon i.e. T2	=Current Dividend*(1+Growth rate)/(Rate of return-Growth Rate)
Share Price at the horizon i.e. T2	=35*(1+0.04)/(0.06-0.04)
Share Price at the horizon i.e. T2	$ 1,820.00
Company's value at T0 i.e. today	$ 1,603.77	million
Debt value	$            -	million
Equity value	$ 1,603.77	million
No of shares	50.00	million
Share price per share	=1603.77/50
Share price per share	$       32.08