1. DawgCohas1millionshares.Itsestimatedfreecashflowspersharearegivenbelow.Thefirstcashflow is one year from now:

2021 2022 2023 2024 ... $8.00 $9.50 $10.00 $11.00 Grow at 3%

1. If your discount rate for Dawgs stock is 11%, what is your estimate of its price per share? [7]

2. You notice that Dawgs competitor, Cougar Industries, has total expected 2021 cash flows of $15 million and has a total equity value of $210 million. Based on Cougars information, what would you expect Dawgs price per share to be? [6]

3. What might explain the difference between your two estimates of Dawgs price? [6]

4. Consider the free cash flows per share for Dawg Co. in part (a). Assume that Dawg announced that it was undertaking an investment that will decrease its free cash flows by $0.40 per share in 2021, but increase its free cash flows per share in 2022 by $0.60 (cash flows would return to normal thereafter). Show that this project is a positive NPV project and that Dawgs shareholders are better off. [6]

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WINTER 2020 SECTION A NAME______________________________

(continuing the Dawg Co. question) After Dawg Co. announces the new investment project, will its stock price steadily climb to the new price you calculated in part (d) over the next year or will it jump immediately to the new price? Explain. [6]

2. Giventhetaxadvantageofdebt,whydontfirmsusemostlydebtforfinancing?[6]

3. Isitpossibleforthestocksoftwocompaniesinthesameindustrytohavedifferentbetas?Explain.[6]

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WINTER 2020 SECTION A NAME______________________________

4. StockBhasanexpectedreturnof10%,stockChasabetaof1.2andastandarddeviationof0.4. Stock D has twice as much exposure to systematic risk as stock C. If you put 30% of your money in B, 40% in C and 30% in D, what will the beta of your portfolio be? [6]

5. Yourgroupandanothergrouparecomparingyourstockportfoliosfromclass.Onepersonnotesthat even though your portfolio had a higher standard deviation, it had a lower return. How could this be true? [6]

6. Explainwhywecanusethedividendyieldofpreferredstockasthepreferredstockinvestorsrequired return. [6]

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WINTER 2020 SECTION A NAME______________________________

7. BFIisbuyingPAEfor$500million.Botharecurrently100%equityfinanced.BFIhasanassetbetaof1.0 and PAE also has an asset beta of 1. Before the transaction was announced, BFI was expected to have FCF to equity of $100 million per year forever. BFI is financing the purchase of PAE entirely with permanent debt.

a. What will be the total value of the new combined firm? [8]

b. What will be the beta of the stock of the combined firm? [6]

c. What will be the pretax and aftertax WACCs of the combined firm? [6]

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WINTER 2020 SECTION A NAME______________________________ 8. Explaintherelationshipsamongpayoutratio,returnonnewinvestmentanddividendgrowth.[6]

9. Yourfirmhasapretaxvalueof$500millionandyourcapitalstructureis100%equity.Youhave10 million shares outstanding. a. What is the price of each share? [7]

b. If you announce that you are permanently borrowing $100 million and buyingback $100 million in stock, how many shares will you buy? [6]