COMMON AND PREFERRED SHARES

1. What are the main differences between debt capital and equity capital?

2. Who are the common shareholders?

3. What are preemptive rights? What does an offer of rights consist of?

authorized shares
treasury shares and issued shares.

5. What rights do preferred shareholders have regarding the distribution of profits?

(dividends) and assets?

6. Explain the cumulative feature of preferred shares.

What is the purpose of a redemption option in a preferred stock issuance?

8. What are convertible preferred shares?

9. What general procedures must a private company follow to go public through

of an initial public offering (IPO)?

10. What role does an investment bank play in a public offering? Describe how it works.
a placement union.

11. Slater Lamp Manufacturing has an outstanding issuance of preferred shares with a
par value of $80 and an annual dividend of 11%.
a. What is the annual dividend in dollars? If this is paid quarterly, how much will it pay?
company every quarter?
b. If the preferred shares are non-cumulative and the board of directors did not pay the dividends
preferred from the last three quarters, how much must the company pay to the shareholders
preferred in this quarter before distributing dividends among shareholders
common?
c. If the preferred shares are cumulative and the board of directors did not pay the dividends
preferred from the last three quarters, how much should the company pay to the shareholders
preferred in this quarter before distributing dividends among the shareholders
common?
 VALUATION OF SHARES:
ZERO GROWTH OF DIVIDENDS

12. (Gitman, p. 312 PDF). Example 7.2

Chuck Swimmer expects the dividend from Denham Company, an established producer of
textiles, remains constant indefinitely at $3 per share. If the required return
The value of his shares is 15%, what is the value of his shares?

13. (Block, p. 283 PDF). Example

Calculate the price of a stock that pays a fixed annual dividend of $1.87 if the risk-free rate
The risk is 4% and the equity risk premium is 8%.

14. (Ehrhardt, response p. 637 PDF). Exercise 7.13

Ezzell Corporation issued preferred stock with a declared dividend of 10% at par.
The type of bonds that produce 8% today and their par value is $100. Assume that the dividends are
they pay annually.
a. What is the price of the company's preferred shares?
b. Suppose that the level of interest rates reaches a point where they yield 12% in the
current moment. How much will their preferred shares be worth?

c. According to the results obtained in sections a) and b), what effect does it produce
risk in the value of stocks? Explain your answer.

15. Kelsey Drums, Inc. is a well-established supplier of fine percussion instruments for
orchestras throughout the territory of the United States. The company's class A common shares
they paid an annual dividend of $5 per share for the last 15 years. The management
expects to continue paying the same rate for the foreseeable future. Sally Talbot bought 100
Kelsey class A common stock ten years ago when the required rate of return
The shares were at 16%. She wants to sell her shares today. The rate of return
The current yield on the shares is 12%. What capital gain or loss will Sally obtain?
of their actions?

16. (Ross, response p. 1003 PDF). Exercise 9.8

Ayden, Inc. has an outstanding issue of preferred stock that pays a dividend.
of 6.40 every year in perpetuity. If this issuance is currently sold at 103 dollars for
action, what is the required performance?

17. (Ehrhardt, response p. 636 PDF). Exercise 7.4

Fee Founders has preferred shares outstanding that pay an annual dividend of $5.
Preferred shares are sold at $60 each. What is the required rate of return?
 EVALUATION OF SHARES:
CONSISTENT GROWTH OF DIVIDENDS

18. (Van Horne, p. 107 PDF). Example

Assume that the expected dividends per share of LKN, Inc. in the next period will be worth
$4, which will increase at a rate of 6% forever, and the appropriate discount rate is
14 percent. Calculate the value of LKN stock.

19. (Ross, p. 302 PDF). Example 9.2

Suppose an investor is considering the purchase of a stock from Utah Mining
Company. The stock will pay a dividend of 3 dollars in a year. It is expected that this
dividend will grow 10% annually in the foreseeable future. The investor believes that the return
what is required for this action is 15%, given the risk assessment of Utah Mining.
a. What will be the price of a Utah Mining stock?
b. If the dividend growth rate had been estimated at 12.5%, what would it have been?
the value of the stock?

20. (Block, p. 284 PDF). Example

A stock is expected to pay a dividend at the end of the year of $2. If the discount rate is
of 12% and a constant growth rate of dividends of 7% is estimated:
a. Calculate the current price of the stock.
b. If the dividend remains at $2 and the growth rate is 7%, but the yield
required increases from 12% to 14%, what will the stock price be?
c. Suppose that the dividend remains at $2, the required return remains at its
previous level of 12% and the growth rate of dividends rises from 7 to 9%. Calculate
the price of the stock.

21. (Ross, response p. 1003 PDF). Exercise 9.2

The next dividend payment from ECY, Inc. will be $2.85 per share. It is expected that the
dividends will maintain a growth rate of 6% forever. If currently the
ECY shares are sold for 58 dollars each, what is the required yield?

22. (Dumrauf, response p. 699 PDF). Exercise 6.3

It is expected that the dividends per share of the company Manguinhos will grow indefinitely at
5% annual, accompanying the general growth of the economy. If the dividend for next year
is $10 and the required market return is 10%, what is the current price of the
action?
23. (Berk, page 295 PDF). Example
In early 2016, Kenneth Cole Productions (KCP) paid annual dividends of $0.72.
a cost of equity of 11% and an expected growth of 8%. Calculate the price per
action.

24. (Brealey, answer p. 1018 PDF). Exercise 5.5

The earnings and dividends per share of company Z are likely to increase significantly.
undefined at 5% per year. If the dividend for next year is 10 dollars and the rate of
The market capitalization is 8%, what is the current stock price?

25. Elk County Telephone paid the dividends presented in the following table during the last
6 years

YEAR DIVIDEND
2016 $2.25
2017 $2.37
2018 $2.46
2019 $2.60
2020 $2.76
2021 $2.87

The company's expected dividend per share is $3.01 next year.

a. If you can earn 13% on similar risk investments, what is the maximum that
Would you be willing to pay per action?
b. If you can only earn 10% on similar risk investments, how much is it
maximum you would be willing to pay per share?
c. Compare the results obtained in items a) and b) and analyze the effect of risk.
variable in the value of the shares.

26. (Berk, p. 308 PDF). Example 9.11

Assume that the company Tecnor Industries will pay a dividend of $5 per share this year. Its
the cost of equity is 10% and you expect your dividends to grow by around
4% annually, although he is unsure of the exact growth rate. If Tecnor's stocks
they currently trade at $76.92 each, how would you update your beliefs about the rate
of dividend growth?
27. With the following information about Foster Company, calculate the risk premium of its shares.
common.
Current price per common share: $50
$3
Constant annual dividend growth rate: 9%
Risk-free rate of return: 7%

28. (Ehrhardt, response p. 636 PDF). Exercise 7.3

Harrison Clothiers' shares are selling today at $20 each. They have just paid a dividend.
of $1 per share. Dividends are expected to grow at a constant rate of 10% per year.
a. What price is expected in 1 year?
b. What is the required rate of return on the stocks?

29. (Ehrhardt, response p. 623 PDF). Self-assessment problem 7.1

The current stock price of Ewald Company is $36 and the last dividend was $2.40.
The required rate of return is just 12%, considering its strong position.
financial and its consequent low risk. If it is expected that in the future dividends will grow to
a constant rate and if it is anticipated that the required rate of return will remain at 12%,
What will be the expected price of the shares after 5 years?

EVALUATION OF SHARES:
Variable Growth of Dividends

30. (Van Horne, p. 108 PDF). Example

Calculate the price of a stock if dividends per share are expected to grow at a rate
compounded at 10% for five years and then at a rate of 6%, the current dividend is $2
per share and the required rate of return is 14 percent.

31. (Dumrauf, response p. 700 PDF). Exercise 6.7

Suppose that investors believe that the shares of Cabañas Paul will grow by 5% only during
five years, to then drop to 2% What would be the price of Cabañas Paul stocks if the
The expected return is 15% and the dividend for next year will be $100?

32. (Ross, answer p. 1003 PDF). Exercise 9.13

North Side Corporation is expected to pay the following dividends over the next four years.
next: $9, $7, $5, and $2.50. Then the company commits to maintaining a rate.
constant dividend growth of 5% forever. If the required yield
About the shares is 13%, what will be the current price of the shares?
33. (Gitman, p. 315 PDF). Example 7.4
Victoria Robb is considering the purchase of common stock in Warren Industries, a
fast-growing boat manufacturer. She learns that the most recent annual payment
(2022) dividends were $1.50 per share. Victoria estimates that these dividends will
They will increase at an annual rate of 10% over the next three years due to the launch.
of a novel boat. At the end of the three years, he hopes that the consolidation of the product of
the company reports a decrease in the dividend growth rate of 5%
annual in the immediate future. The required return by Victoria is 15%. Use the model
variable growth to determine the stock price.

34. (Ehrhardt, answer p. 623 PDF). Self-assessment problem 7.2

Snyder Computer Chips Incorporated is going through a period of rapid growth. It is expected that
profits and dividends increase at a rate of 15% in the next 2 years, at 13% in
the third year and then the rate remains constant at 6%. The last dividend was
$1.15 and the required rate of return on the stock is 12%. Calculate the present value of
the actions.

35. (Berk, p. 294 PDF). Example 9.5

The company Small Fry, Inc., has just invented a potato slice that looks and tastes like it
it was cooked French style. Given the phenomenal response the market had to this
product, the company reinvests all its profits to expand its operations. The
Earnings were $2 per share last year and are expected to grow at a rate of 20% per year until
the end of year 4. At that time, it is likely that other companies will launch products
Competitors. Analysts project that by the end of year 4, Small Fry will cut the
research and will start paying 60% of its profits as dividends and its growth
it will decrease at a rate of 4% in the long term. If Fry's cost of capital is 8%, what is the value
of one of its actions today?

VALUATION MODEL FOR FREE CASH FLOW

36. (Ehrhardt, response p. 623 PDF). Self-assessment problem 13.1

Watkins Incorporated never paid dividends, and it is unknown when it might start.
do it. It has a free cash flow of $100,000 and expects it to grow at a constant rate
from 7%. The weighted average cost of capital is 11%. It has $325,000 invested in securities.
non-operational negotiables. Its long-term debt amounts to $1,000,000, but has never.
issued preferred shares.
a. Calculate the value of the operations.
b. Calculate the total value of the company.
c. Calculate the value of the share capital.
d. If there are 100,000 common shares outstanding, what is the price per share?
37. (Gitman, p. 317). Example 7.5
Dewhurst, Inc. wants to determine the value of its shares using the valuation model of
free cash flow. To apply the model, the financial manager of the company developed the
data presented in the following table:

YEAR FEL Other data

2023 $400,000 FEL growth rate, from 2027 = 3%
2024 $450,000 Weighted average cost of capital = 9%
2025 $520,000 Market value of all debt = $3,100,000
2026 $560,000 Market value of preferred stock = $800,000
2027 $600,000 Number of common shares outstanding = 300,000
a. Calculate the value of the entire company.

b. Calculate the value of common stocks.

c. Calculate the price per share.

38. (Berk, p. 299 PDF). Example 9.7

In 2022, Kenneth Cole (KCP) projected the free cash flows shown in the following table.
The growth rate from 2028 is estimated based on the long-term growth rate of
the textile industry, 4%. If KCP has $100 million in cash, $3 million in debt, 21 million
of shares outstanding and a weighted average cost of capital of 11%, what is the
estimation of the total company value and of KCP's share at the beginning of 2023?

FEL
YEAR
(millions of dollars)
2023 $27.4
2024 $30.1
2025 $32.7
2026 $35.3
2027 $37.7
2028 $39.9

39. (Berk, p. 309 PDF). Example 9.12

The company Myox Labs announces that due to potential side effects, it withdraws from
market one of its leading medicines. As a result, its future free cash flow
expected to decrease by $85 million in each of the following ten years. Myox has 50
millions of shares outstanding, has no debt, and its cost of equity is 8%. If
these news were a total surprise for investors, what should happen with the
price of Myox shares due to the announcement?
 OTHER VALUATION METHODS

40. (Berk, p. 303 PDF). Example 9.9

Imagine that the furniture manufacturer Herman Miller, Inc. earns $1.38 in earnings per share.
If the average P/E of comparable furniture stores is 21.3, estimate the value of Herman.
Miller with the use of P/E as a valuation multiple. What are the assumptions behind it?
this estimate?

-----------------------------------------------------------------------------------------------------------------------------------
 FORMULAS

• Zero growth model

1
0=

• Constant growth model or Gordon model

1
0=
−

1= 0∗ (1+ 1)

1
= ( +)
0

1
= − ( +)
0

[( 0∗ )− 0]
=
( 0+ 0 )

• Variable growth model

1+ 1
1− ( )
1+ +
+1
0= 1
− 1 ( − 2)∗ (
1+ )

+1= ( 0∗
) 1+ ( 2 )

( ) −1
+1= 1 ∗( 1+ 2 )

• Price/Earnings Ratio (P/E)

0= 1∗ ( / )

• Value of operations

∗ (1+ )
0p =
−
BIBLIOGRAPHY

Berk, Jonathan and Demarzo, Peter (2008). Corporate Finance. 1st ed. Pearson Education, Mexico.

Block, Stanley B.; Hirt, Geoffrey A.; and Danielsen, Bartley R. (2013). Fundamentals of Management
Financial. 14th ed. McGraw-Hill/Interamericana Editors, Mexico.

Brealey, Richard A.; Myers, Stewart C.; and Allen, Franklin (2010). Principles of Corporate Finance.
10th ed. McGraw-Hill/Interamericana Publishers, Mexico.

Corporate Finance: A Latin American Approach

Alfaomega Argentine Publishing Group, Buenos Aires.

Corporate Finance
Editors, Mexico.

Principles of Financial Management

Pearson Education, Mexico.

Corporate Finance
McGraw-Hill/Interamericana Publishers, Mexico.

Fundamentals of Financial Management

ed. Pearson Education, Mexico.