Corporate Finance - Present Value Exercises II Questions

Instructions:.

You should submit an electronic copy of your excel solution on Canvas. Preparation of problem sets should be done individually, but you are allowed to discuss the related concepts with your learning team. Your solution should be formatted and laid out so that it is easy to read and clearly shows your work, the logic behind your answers, and any assumptions you made in the analysis.

Questions Based on Session 5

2 Fast-Track Inc is a worldwide delivery company that is expected to generate a dividend (per share) of $1.20 one year from now (i.e. at t=1). You are expecting that on average Fast-Track Inc’s dividends will grow at 6% each year after that into the indefinite future. Assume for simplicity that all dividends are paid at the end of each year. Suppose that the appropriate
discount rate for these dividends is 9%.
a) What is the current stock price for Fast-Track Inc? Assume that any dividend at t=0 has already been paid out.
b) What do you expect the stock price of Fast-Track to be next year (i.e. at t=1) immediately after the dividend has been paid out?
c) What is the expected return for holding the stock of Fast-Track over the year ahead?
Hint: Find the IRR on the expected cash flows from buying and holding the stock for one year. The cash flows should include the purchase and sale of the stock as well as the dividend you will receive. Now consider a second firm in the same industry called Slow-Track Inc. Slow-Track also has an expected dividend per share of $1.20 one year from now (i.e. at t=1). However, you expect that Slow-Track is going to grow at a much slower rate and hence dividends are going to increase at 2% each year. The discount rate for Slow-Track is the same as for Fast-Track.
d) What is the current stock price for Slow-Track Inc? Assume that any dividend at t=0 has already been paid out.
e) What do you expect the stock price of Slow-Track to be next year (i.e. at t=1) immediately after the dividend has been paid out?
f) What is the expected return for holding the stock of Slow-Track over the year ahead?
Hint: Find the IRR on the expected cash flows from buying and holding the stock for one year. The cash flows should include the purchase and sale of the stock as well as the dividend you will receive.
g) A friend of yours claims that Fast-Track is a better investment because it is expected to grow faster than Slow-Track. Is your friend correct? Assume that both stocks are equally risky. Give the intuition for your answer in one or two sentences.
h) Would your answer to g) change if you planned on holding either stock for longer (e.g. for 30 years)?