Principles of Managerial Finance

CHAPTER 7 Stock Valuation 349

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http://www.aw.com/gitman

for additional resources, including additional Web exercises.

investment is undertaken, the 2004 dividend will rise to $2.15 per share and the

annual rate of dividend growth will increase to 13%. She feels that in the best

case,the dividend would continue to grow at this rate each year into the future

and that in the worst case,the 13% annual rate of growth in dividends would

continue only through 2006, and then, at the beginning of 2007, would return

to the rate that was experienced between 1999 and 2003. As a result of the

increased risk associated with the proposed risky investment, the required return

on the common stock is expected to increase by 2% to an annual rate of 16%,

regardless of which dividend growth outcome occurs.

Armed with the preceding information, Inez must now assess the impact of

the proposed risky investment on the market value of Suarez’s stock. To simplify

her calculations, she plans to round the historical growth rate in common stock

dividends to the nearest whole percent.

Required

a. Find the currentvalue per share of Suarez Manufacturing’s common stock.

b. Find the value of Suarez’s common stock in the event that it undertakes the

proposed risky investmentand assuming that the dividend growth rate stays

at 13% forever. Compare this value to that found in part a.What effect

would the proposed investment have on the firm’s stockholders? Explain.

c. On the basis of your findings in part b,do the stockholders win or lose as a

result of undertaking the proposed risky investment? Should the firm do

it? Why?

d. Rework parts band cassuming that at the beginning of 2007 the annual divi-

dend growth rate returns to the rate experienced between 1999 and 2003.

WEB EXERCISE To use the price/earnings multiples approach to valuation, you need to find a
firm’s projected earnings and the P/E multiple. One of the most popular sites to
obtain these estimates is Zacks Investment Research, http://www.zacks.com.

1. At the top of the page, locate the area where you can enter a company’s
   ticker symbol and select the desired information.


2. Enter OO for Oakley Inc. and select estimatesfrom the pull-down menu.
   a. What is the current mean/consensus estimate for the next fiscal year’s
   earnings?
   b. Using the indicated price/earnings ratio further down on that page, cal-
   culate the stock price.


3. Repeat steps 2aand bfor the following stocks:
   a. Southwest Airlines: LUV
   b. Microsoft: MSFT
   c. Weight Watchers: WTW