1) Valerian Corp. convertible preferred stock has a fixed conversion ratio of five common shares per one share of preferred stock. The preferred stock pays a dividend of $10.00 per share per year. The common stock currently sells for $20.00 per share and pays a dividend of $1.00 per share per year.

On the basis of the conversion ratio and the price of the common shares, what is the current conversion value of each preferred share?

If the preferred shares are selling at $96.00 each, should an investor convert the preferred shares to common shares? What factors might cause an investor not to convert from preferred to common stock?

2) Home Place Hotels Inc. is entering into a three-year remodeling and expansion project. The construction will have a limiting effect on earnings during that time, but when completed, it should allow the company to enjoy much improved growth in earnings and dividends. Last year, the company paid a dividend of $3.40. It expects zero growth in the next year. In years two and three, 5% growth is expected, and in year four, 15% growth. In year five and thereafter, growth should be a constant 5% per year.

What is the maximum price per share that an investor who requires a return of 14% should pay for Home Place Hotels common stock?

3) You are evaluating the potential purchase of a small business with no debt or preferred stock that is currently generating $42,500 of free cash flow (FCF0=$42,500) On the basis of a review of similar-risk investment opportunities, you must earn an 18% rate of return on the proposed purchase. Because you are relatively uncertain about future cash flows, you decide to estimate the firms value using several possible assumptions about the growth rate of cash flows.

What is the firms value if cash flows are not expected to grow at all?

What is the firms value if cash flows are expected to grow at a constant annual rate of 7% forever?

What is the firms value if cash flows are expected to grow at an annual rate of 12% for the first two years, followed by a constant annual rate of 7%?

4) For each of the firms shown in the following table, use the data given to estimate its common stock value employing price/earnings (P/E) multiples.

Firm Exp. EPS Price/Earnings Multiple

A $3.00 6.2

B $4.50 10.0

C $1.80 12.6

D $2.40 8.9

E $5.10 15.0

5) Giant Enterprises stock has a required return of 14.8%.

The company, which plans to pay a dividend of $2.60 per share in the coming year, anticipates that its future dividends will increase at an annual rate consistent with that experienced over the 20162022 period, when dividends increased from $1.73 to $2.45.

If the risk-free rate is 4%, what is the risk premium on Giants stock?

Using the constant-growth dividend model, estimate the value of Giants stock.

Explain what effect, if any, a decrease in the risk premium would have on the value of Giants stock.