Question

Perryville Corp. has an enterprise value of $50,000,000, long term debt of $8,000,000, and an under-funded pension obligation of $6,000,000. If it has 1,800,000 shares outstanding (and no shares under option), please compute the intrinsic value per common share.

Assume the same information as the prior problem. In addition, Perryville Corp. has 600,000 shares under option and in the money. Please use the denominator method and assume that all 600,000 options will be exercise (with no proceeds because future grants will offset the proceeds). In addition, Perryville issued an additional 100,000 shares and the $10,000,000 in cash from the sale of shares is added to the $50,000,000 enterprise value for a new enterprise value of $60,000,000. What is the new intrinsic value per common share?

Marsha Corporation is financed as follows:
--60,000 bonds with market values of 92% of face value of $1,000.
--80,000 shares of preferred stock trading in an active market at $15 per share
--1,000,000 shares of common stock trading in an active market at $32 per share
--The bonds pay $60 interest payments annually, have a face value of $1,000 and trade in the market at $920
--The preferred stock pays a $2.00 dividend with no growth.
--The common stock has a beta of 1.5, the risk-free rate is 3.5%, and the market risk premium is 6%.

Given the information above, what is the weighted average cost of capital for Marsha Corporation?

ABC Corporation just paid a $2.08 dividend and is expected to grow at the following rates – year 1 at 6%, year 2 at 8%, year 3 at 10%, year 4 at 12 % , year 5 at 8% and thereafter at 3%, The cost of equity using the capital asset pricing model is 8%. What is the value for ABC Corporation using the dividend discounting model?

Answer 1

1) Perryville Corp. has an enterprise value of $50,000,000, long term debt of $8,000,000, and an under-funded pension obligation of $6,000,000. If it has 1,800,000 shares outstanding (and no shares under option), please compute the intrinsic value per common share.

Answer:

Enterprise Value is total value of the firm including equity value and debt value. To find out intrinsic value, i.e. per share value of an ordinary share, we should reduce all non-equity portion form the Enterprise Value. Conservatively, an underfunded pension obligation should also be deducted from it. An underfunded pension lability arises when the pension fund has more liabilities than its assets under a defined retirement (pension plan). This shortfall needs to be funded by cash funding or stock funding by the company. So, it is prudent to deduct these liabilities from the Enterprise value.

Total Intrinsic Value = Enterprise Value – Long Term debt – underfunded pension obligation

Total Intrinsic Value = $50,000,000 - $8,000,000 - $6,000,000 = $36,000,000

Intrinsic Value per share = Total Intrinsic Value / Shares outstanding

Intrinsic Value per share = $36,000,000 / 1,800,000 = $20

2) Assume the same information as the prior problem. In addition, Perryville Corp. has 600,000 shares under option and in the money. Please use the denominator method and assume that all 600,000 options will be exercise (with no proceeds because future grants will offset the proceeds). In addition, Perryville issued an additional 100,000 shares and the $10,000,000 in cash from the sale of shares is added to the $50,000,000 enterprise value for a new enterprise value of $60,000,000. What is the new intrinsic value per common share?

Answer:

New Intrinsic Value = Existing Intrinsic Value (as per last problem) + Cash Proceeds from new share issue

New Intrinsic Value = $36,000,000 + $10,000,000 = $46,000,000

Total number of outstanding shares = existing Shares + options converted + new share issue

Total number of outstanding shares = 1,800,000 + 600,000 + 100,000 = 2,500,000

Intrinsic Value per share = Total New Intrinsic Value / New Shares outstanding

Intrinsic Value per share = $46,000,000 / 2,500,000 = $18.4

3) Marsha Corporation is financed as follows:
--60,000 bonds with market values of 92% of face value of $1,000.
--80,000 shares of preferred stock trading in an active market at $15 per share
--1,000,000 shares of common stock trading in an active market at $32 per share
--The bonds pay $60 interest payments annually, have a face value of $1,000 and trade in the market at $920
--The preferred stock pays a $2.00 dividend with no growth.
--The common stock has a beta of 1.5, the risk-free rate is 3.5%, and the market risk premium is 6%.

Given the information above, what is the weighted average cost of capital for Marsha Corporation?

Answer:

For finding out we will take the market value weight of different instruments.

1) Market value of Equity = No. of outstanding shares x Market Price

   Market value of Equity = 1,000,000 x $32 = $32,000,000

2) Market value of Preference Shares =No. of outstanding Preference Shares x Market Price

   Market value of Preference Shares = 80,000 x $15 = $1,200,000

3) Market value of Debt= No. of outstanding bonds x Market Price

Market value of Debt = 60,000 x $920 = $55,200,000

4) Total Value of all instrument = $32,000,000 + $1,200,000 + $55,200,000 = $88,400,000

Now the weights of respective instruments would be

1) Weight of Equity (we) = Market Value of Equity / Total Value of Instruments

    Weight of Equity (we) = $32,000,000 / $88,400,000 = 36.20%

2) Weight of Preference Shares (wp) = Market Value of Preference Shares / Total Value of Instruments

   Weight of Preference Shares (wp) = $1,200,000 / $88,400,000 = 1.36%

3) Weight of Debt (wd) = Market Value of Debt / Total Value of Instruments

   Weight of Debt (wd) = $55,200,000 / $88,400,000 = 62.44%

Now, we need to find the respective cost of capital for these instruments.

1) Cost of Equity For the cost of equity (Ke), we will use, Capital Asset Pricing Model – CAPM Model, as per this model,

Cost of equity = Risk Free rate + Beta x Market Risk Premium

Cost of equity (Ke) = 3.5% + 1.5(6%) = 12.5%

2) Cost of Preferred Share: For the cost of preference share (Kp), we will use, following formula assuming they are irredeemable

Cost of preference (Kp) = Preference Dividend / Market Price of Preference Share

Cost of preference (Kp) = $2 / $ 15 = 13.33%

3) Cost of Bonds For the cost of preference share (Kd), we will use, following formula, current yield formula, as we are not given their maturity.

Cost of Debt (Kd) = Coupon / Market Price of Debt

Cost of Debt (Kd) = $60 / $ 920 = 6.52%

We have assumed no tax rate.

Finally, we will calculate, the Weighted Average Cost of Capital - WACC

WACC = we x Ke + wp x Kp + wd x Kd

WACC = 36.20% x 12.5% + 1.36% x 13.33% + 62.44% x 6.52%

WACC = 8.77%

Assuming, 50% tax rate

Cost of Bonds = Pre-Tax Cost of Debt x (1- Tax Rate)

   = 6.52% (1-0.5) = 3.26%

Accordingly, the Weighted Average Cost of Capital – WACC, would be

WACC = we x Ke + wp x Kp + wd x Kd

WACC = 36.20% x 12.5% + 1.36% x 13.33% + 62.44% x 3.26%

WACC = 6.74%

4) ABC Corporation just paid a $2.08 dividend and is expected to grow at the following rates – year 1 at 6%, year 2 at 8%, year 3 at 10%, year 4 at 12 % , year 5 at 8% and thereafter at 3%, The cost of equity using the capital asset pricing model is 8%. What is the value for ABC Corporation using the dividend discounting model?

Answer:

Here we will, use multi period Dividend Discount Model using cost of equity as 8%

Value of ABC = Year 1 Dividend / (1+r)^1 + Year 2 Dividend / (1+r)^2 +

                        Year 3 Dividend / (1+r)^3 + Year 4 Dividend / (1+r)^4 +

                       Year 5 Dividend / (1+r)^5 + Perpetual Value at Year 5 / (1+r)^5

                Year 1 Dividend = Current Dividend x 1.06 = $2.08 x 1.06 = $2.20

                Year 2 Dividend = Year 1 Dividend x 1.08 = $2.20 x 1.08 = $2.38

                Year 3 Dividend = Year 2 Dividend x 1.10 = $2.38 x 1.10 = $2.62

                Year 4 Dividend = Year 3 Dividend x 1.12 = $2.62 x 1.12 = $2.93

                Year 5 Dividend = Year 4 Dividend x 1.08 = $2.93 x 1.08 = $3.16

                Perpetual Value at the end of year 5 = Year 5 Divided x (1+peratual growth) / (r-g)

                Where, r is cost of equity and g is perpetual growth

                 Perpetual Value at the end of year 5 = $ 3.16 x 1.03 / (0.08-0.03) = $65.10

                                                                              

Value of ABC = $ 2.20 / (1.08)^1 + $ 2.38 / (1.08)^2 + $ 2.62/ (1.08)^3 + $ 2.93 / (1.08)^4 + $ 3.16/ (1.08)^5 + $ 65.10/ (1.08)^5

Value of ABC = $ 2.04 + $ 2.04 + $ 2.08 + 2.15 + $ 2.15 + $44.30

Value of ABC = $ 54.76