[Answer with True (T) or False (F)]

1. For the dividend discount model (DDM) under supernormal growth (or non-constant growth model), the discount rate (r) during the initial supernormal growth period is as same as the discount rate (r) used in the later, steady growth period. ( )

2. For the corporate valuation model (or free cash flow (FCF) discount model) in firm valuation, the cost of common equity (rc) is generally used as a discount rate. ( )

3. If the expected return of a stock based on the current stock price (P0) is located above the security market line (SML), then a stock analyst would issue a coverage report with a buy recommendation. ( )

4. If the internal rate return (IRR) and the net present value (NPV) methods give conflicting results between mutually exclusive projects, the project with a higher NPV should be chosen. ( )

Choose a correct statement among the following options regarding stock valuation. ( )

1 The dividend discount model under steady growth is a suitable model for a newly- listed technology firm expected to undergo a stable growth phase in 5 to 10 years.

2 For a stock with a 12% required return, if the dividend payout is expected to grow steadily at 5% (g=5%), the expected dividend yield in the following year is also 5%. 3 Even when a negative dividend growth is expected, a constant-growth dividend discount model (P0 = D1 (rsg) ) can be used.

4 The intrinsic value of a stock is the total discounted value of all future expected dividend payouts using the dividend growth rate (g) as the discount rate.

5 For a firm with zero expected growth of dividend, the dividend discount model under constant growth cannot be used.

6. Choose a wrong statement regarding capital budgeting. ( ) 1 For a business project with a negative net present value (NPV), its internal rate of return (IRR) must be lower than the weighted average cost of capital (WACC) used to evaluate the project. 2 Because the NPV and IRR of mutually exclusive projects can give opposite results, entirely depending on the IRR method to choose a business project can minimize the risk of misjudgment. 3 The big difference between the NPV and IRR methods lies on the assumption regarding the reinvestment of cash flows during the investment periods. 4 The IRR and NPV methods always give the same results for independent projects.

The risk of stocks can be measured in two types: First, a stand-alone risk, the risk an investor would face if he or she held only one asset which can be represented by the variance or standard deviation. Second, a systematic risk, the risk that remains on a portfolio after diversification has eliminated all company-specific risk which can be measured by the beta. The capital asset pricing model (CAPM) uses the beta to estimate the required return to investing a stock. (1) Calculate the required return to SUNNY Inc.s stock given that the risk-free rate is at 5%, the market risk premium is at 3% (or the expected market return at 8%), and the beta of SUNNY, Inc. is at 1.2. (3 points)

(2) SUNNY, Inc., paid a $10/share dividend in the last fiscal period and its net profits are expected to grow at 5%. How much should SUNNY, Inc.s stock trade per share? (3 points)

SUNYK, Ltd. plans to payout a $1 per share dividend at the end of this fiscal period. The dividend is expected to constantly grow at 5% per period. SUNYKs required return is 10% and the company currently trades at $22 per share. Please recommend your investors for a decision among hold, buy, or sell and give your reasoning. (5 points)

10. Stony Brook Corp. recently paid an annual $15 per share dividend. From the recently approved patent, this companys net profits will grow at 20% in the next 2 years, and at 5% in the third year and beyond due to expiration of the patent. The required return to this companys shareholders is at 10%. (1) Calculate the intrinsic value of Stony Brooks stock per share. (4 points)

(2) Calculate the dividend yield and the capital gains yield for the first year (t=0). Round up to the first decimal point if your answer is expressed in percentage (%) (or up to the third decimal point if written in fraction). (4 points)

(3) Calculate the dividend yield and the capital gains yield for the third year (as at the beginning of the third year (t=2)). Round up to the first decimal point if your answer is expressed in percentage (%), or up to the third decimal point if written in fraction. (4 points)

(4) What is the expected stock price of this company in five years? Round up to the second decimal point. Provide all your calculation for partial points. (4 points)

There a project for SBU, Inc. with expected cash flows describe below.

Answer the following questions with the additional information give below. (25 points total)

Tax rate = 40% Capital structure

Debt: Face value at $1,000; 10 years of maturity; 10% semiannual coupons; price $885.30; no addition cost of new debt issuance. Preferred stock: $10 annual dividend per share; price $111.10. Common stock: Price $42; dividend payout (D0) at $4 per share; steady growth of net profits expected at 5% per year Beta at 1.3; risk-free rate (rf) at 8%; market risk premium at 6% For illiquid (infrequently traded) stocks, 3-5% bond-yield risk premium is added to the long-term bond yield.

(1) Calculate the cost of debt capital (before and after tax) assuming no floatation costs. (3 points)

(2) Calculate the cost of preferred stock assuming no floatation costs. (3 points)

(3) Calculate the cost of common stock assuming no floatation cost. i. Use the dividend discount model (DDM) under steady growth (Gordon model). (3 points)

ii. Use the capital asset pricing model (CAPM). (3 points)

iii. Add the mid-point of 3-5% bond-yield premium to the long-term bond yield obtained from Part 1. (3 points)

(4) Using the average of the three measures of the common stock cost of capital from Part 3 as the cost of common stock, calculate the weighted average cost of capital (WACC). (4 points)

(5) Calculate the internal rate of return (IRR) and the net present value (NPV) of the project as follows: (4 points) i. IRR:

ii. NPV:

(6) Decide whether to accept or reject the project. (2 points)