Finance 1 – Tutorial 4

9.2 a) Expected dividend yield:

Anle Corporation has a current 𝐷𝑖𝑣! $2

= = 0.118
price of $17, is expected to pay a 𝑃" $17
dividend of $2 in one year, and its
expected price right after paying
b) Expected capital gain rate:
that dividend is $18.
𝑃! − 𝑃" 𝑃! $18
= −1= − 1 = 0.059
a) What is Anle’s expected 𝑃" 𝑃" $17
dividend yield?
c) Equity cost of capital (equation 9.1 and 9.2):

b) What is Anle’s expected capital 𝐷𝑖𝑣! + 𝑃!

gain rate? 𝑃" =
1 + 𝑟#

𝐷𝑖𝑣! 𝑃!$ 𝑃"

c) What is Anle’s equity cost of ⇒ 𝑟# = +
𝑃" 𝑃"
capital?
𝑟# = Expected dividend yield + Expected capital gain rate = 0.118 + 0.059
= 0.177

The total return is the expected return that the investor will earn for a one-year
investment in the stock.
9.11 v First, calculate the cost of capital of the firm before the
announcement by using constant dividend growth
Cooperton Mining just announced it model (9.6):
will cut its dividend from $4.27 to
$2.67 per share and use the extra
funds to expand. Prior to the 𝐷𝑖𝑣 𝐷𝑖𝑣
𝑃= ⇒ 𝑟3 = +𝑔
announcement, Cooperton’s 𝑟3 − 𝑔 𝑃
dividends were expected to grow at
a 2.9% rate and its share price was
$49.06. With the new expansion, $4.27
Cooperton’s dividends are 𝑟3 = + 2.9% = 11.6%
$49.06
expected to grow at 4.8% rate.
What share price would you expect
after the announcement? (Assume v Now we can calculate the expected price after the
Cooperton’s risk is unchanged by announcement assuming Cooperton’s risk or 𝑟3 is
the new expansion.) Is the unchanged.
expansion a positive NPV $2.67
investment? 𝑃′ = = $39.26
11.6% − 4.8%

v It’s a negative NPV expansion:

𝑁𝑃𝑉 = 39.26 − 49.06 < 0
 a) We can estimate a firm’s enterprise value by computing the
present value of the free cash flow (FCF) that the firm has
available to pay all investors, both debt and equity holders
9.19 (discounted free cash flow model):

Heavy Metal Corporation is

expected to generate the following
free cash flows over the next five
years:
Year 1 2 3 4 5
FCF ($ milions) 52.2 68.7 77.2 75.6 80.5 v Note that we use 𝑟!"## as the discount rate instead of 𝑟$ :

After then, the free cash flows are 𝐹𝐶𝐹& 𝐹𝐶𝐹' 𝐹𝐶𝐹( + 𝑉(
expected to grow at the industry
𝑉% = 𝑃𝑉 𝐹𝐶𝐹 = &
+ '
+ ⋯+
1 + 𝑟!"## 1 + 𝑟!"## 1 + 𝑟!"## (
average of 4.1% per year. Using
the discounted free cash flow
model and a weighted average Where the terminal value is estimated by assuming a constant
cost of capital of 14.9%: long-run growth rate 𝑔)#) for FCF beyond year N, so that

𝐹𝐶𝐹(*& 1 + 𝑔)#)
a) Estimate the enterprise value 𝑉( = = ×𝐹𝐶𝐹(
of Heavy Metal.
𝑟!"## − 𝑔)#) 𝑟!"## − 𝑔)#)

$80.5×1.041
$52.2 $68.7 $77.2 $75.6 $80.5 + 0.149 − 0.041
𝑉% = + + + +
1.149& 1.149' 1.149+ 1.149, 1.149-

𝑉% = $619.39
 9.19 b) Estimation of the share price by using the
Heavy Metal Corporation is
expected to generate the following enterprise value, which we defined in Ch.2:
free cash flows over the next five
years:
Year 1 2 3 4 5 𝐸𝑉 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐷𝑒𝑏𝑡 − 𝐶𝑎𝑠ℎ
FCF ($ milions) 52.2 68.7 77.2 75.6 80.5

After then, the free cash flows are ⇒ $619.39 = 𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 + $306 − $0
expected to grow at the industry
average of 4.1% per year. Using
the discounted free cash flow
model and a weighted average 𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 = $619.39 − $306 + $0 = $313.39
cost of capital of 14.9%:

𝐸𝑞𝑢𝑖𝑡𝑦 $313.39
b) If Heavy Metal has no excess
𝑃= = = $7.46
cash, debt of $306 million, and # 𝑆ℎ𝑎𝑟𝑒𝑠 42
42 million shares outstanding,
estimate its share price.
9.25
Suppose that in January 2006,
Kenneth Cole Productions had
EPS of $1.65 and a book value of
equity of $12.05 per share.
a) Using the average P/E multiple
in Table 9.1, estimate KCP’s
share price.
b) What range of share prices do
you estimate based on the
highest and lowest P/E
multiples in Table 9.1?
c) Using the average price to
book value multiple in Table
9.1, estimate KCP’s share
price.
d) What range of share prices do a) Estimation of a share price using a P/E
you estimate based on the
highest and lowest price to multiplier:
book value multiples in Table 𝑃
9.1? 𝑃= ×𝐸𝑃𝑆 = 15.01×$1.65 = $25.77
𝐸
9.25
Suppose that in January 2006,
Kenneth Cole Productions had
EPS of $1.65 and a book value of
equity of $12.05 per share.
a) Using the average P/E multiple
in Table 9.1, estimate KCP’s
share price.
b) What range of share prices do
you estimate based on the
highest and lowest P/E
multiples in Table 9.1?
c) Using the average price to
book value multiple in Table
9.1, estimate KCP’s share
price.
d) What range of share prices do b) Estimation share price range using P/E multipliers:
you estimate based on the 𝑃
highest and lowest price to 𝑃456 = ×𝐸𝑃𝑆 = 8.66×$1.65 = $14.29
𝐸 456
book value multiples in Table 𝑃
9.1? 𝑃478 = ×𝐸𝑃𝑆 = 22.62×$1.65 = $37.32
𝐸 478
9.25
Suppose that in January 2006,
Kenneth Cole Productions had
EPS of $1.65 and a book value of
equity of $12.05 per share.
a) Using the average P/E multiple
in Table 9.1, estimate KCP’s
share price.
b) What range of share prices do
you estimate based on the
highest and lowest P/E
multiples in Table 9.1?
c) Using the average price to
book value multiple in Table
9.1, estimate KCP’s share
price.
d) What range of share prices do c) Estimation of a share price using a Price-to-
you estimate based on the
highest and lowest price to Book multiplier.
book value multiples in Table 𝑃𝑟𝑖𝑐𝑒
9.1? 𝑃= ×𝐵𝑜𝑜𝑘 = 2.84×$12.05 = $34.22
𝐵𝑜𝑜𝑘
9.25
Suppose that in January 2006,
Kenneth Cole Productions had
EPS of $1.65 and a book value of
equity of $12.05 per share.
a) Using the average P/E multiple
in Table 9.1, estimate KCP’s
share price.
b) What range of share prices do
you estimate based on the
highest and lowest P/E
multiples in Table 9.1?
c) Using the average price to
book value multiple in Table
9.1, estimate KCP’s share
price.
d) What range of share prices do d) Estimation share price range using Price-to-Book multipliers:
you estimate based on the 𝑃𝑟𝑖𝑐𝑒
𝑃./0 = ×𝐵𝑜𝑜𝑘 = 1.12×$12.05 = $13.50
highest and lowest price to 𝐵𝑜𝑜𝑘 ./0
book value multiples in Table 𝑃𝑟𝑖𝑐𝑒
9.1? 𝑃.12 = ×𝐵𝑜𝑜𝑘 = 8.11×$12.05 = $97.73
𝐵𝑜𝑜𝑘 .12
9.25 a) Estimation of a share price using a P/E multiplier:
Suppose that in January 2006, 𝑃
Kenneth Cole Productions had 𝑃= ×𝐸𝑃𝑆 = 15.01×$1.65 = $25.77
EPS of $1.65 and a book value of 𝐸
equity of $12.05 per share. b) Estimation share price range using P/E multipliers:
a) Using the average P/E multiple 𝑃
𝑃456 = ×𝐸𝑃𝑆 = 8.66×$1.65 = $14.29
in Table 9.1, estimate KCP’s 𝐸 456
share price. 𝑃
𝑃478 = ×𝐸𝑃𝑆 = 22.62×$1.65 = $37.32
b) What range of share prices do 𝐸 478
you estimate based on the
highest and lowest P/E c) Estimation of a share price using a Price-to-Book
multiples in Table 9.1? multiplier.
𝑃𝑟𝑖𝑐𝑒
c) Using the average price to 𝑃= ×𝐵𝑜𝑜𝑘 = 2.84×$12.05 = $34.22
book value multiple in Table 𝐵𝑜𝑜𝑘
9.1, estimate KCP’s share d) Estimation share price range using Price-to-Book
price. multipliers:
d) What range of share prices do 𝑃𝑟𝑖𝑐𝑒
you estimate based on the 𝑃456 = ×𝐵𝑜𝑜𝑘 = 1.12×$12.05 = $13.50
𝐵𝑜𝑜𝑘 456
highest and lowest price to 𝑃𝑟𝑖𝑐𝑒
book value multiples in Table 𝑃478 = ×𝐵𝑜𝑜𝑘 = 8.11×$12.05 = $97.73
9.1? 𝐵𝑜𝑜𝑘 478
9.31 a) Apply the perpetuity formula with growth:
In early 2018, Coca-Cola Company
(KO) had a share price of $42.42,
and had paid a dividend of $1.01 𝐷𝑖𝑣9 ×(1 + 𝑔) $1.01×1.066
for the prior year. Suppose you 𝑃 = = = $63.33
𝑟−𝑔 0.083 − 0.066
expect Coca-Cola to raise this
dividend by approximately 6.6%
per year in perpetuity.
b) Based on the market price, our growth forecast is
probably too high. Growth rate consistent with market
a) If Coca-Cola’s equity cost of price is:
capital is 8.3%, what share
price would you expect based
on your estimate of the 𝑔′ = 𝑟3 − 𝐷𝑖𝑣. 𝑦𝑖𝑒𝑙𝑑
dividend growth rate?

$1.01×1.066
b) Given Coca-Cola’s share price, 𝑔: = 0.083 − = 5.76% < 6.6%
what would you conclude about
42.42
your assessment of Coca-
Cola’s future dividend growth?
Kenneth Cole Productions – What Happened?

• Kenneth Cole’s
stock price of
$26.75 in January
2006 is within the
range estimated
by all of these
methods.
Kenneth Cole Productions – What Happened?

Despite strong revenue growth in its wholesale

division, its retail stores suffered an unexpected large
same-store sales decline of 13%. Overall KCP
revenues grew only 3.6% in 2006, well below analysts’
forecasts. Losses in the retail division caused KCP’s
EBIT margin to drop below 7%.
Kenneth Cole Productions – What Happened?

After the departure of its president (Paul

Blum), KCP also struggled to find new
leadership. As both Chairman and CEO,
founder Kenneth Cole was able to spend
less time on the creative aspects of the
brand, and its image suffered. Sales
declined 4.8% in 2007, and its EBIT margin
fell to 1%.
Kenneth Cole Productions – What Happened?

In Spring 2008, KCP hired Jill Granoff, a

former Liz Claiborne executive, as its
new CEO.
Kenneth Cole Productions – What Happened?

In Fall 2008, KCP was hit hard by

the effects of the financial crisis. It
found itself saddled with large
inventories and had to aggressively
cut prices. Worse, KCP reported
operating losses, with an EBIT
margin of -2%.
Kenneth Cole Productions – What Happened?

KCP cut its dividend in half at

the start of 2008 and
suspended dividend payments
altogether at the start of 2009.
70% down
Kenneth Cole Productions – What Happened?

As the economy recovered in

2010, KCP returned to
profitability, and sales
experienced double digit
growth.

In early 2012, Kenneth Cole,

offered to buy the firm from its
shareholders.

The deal closed on Sep. 25th,

2012 for a price of
$15.25/share (below $26.75)