PART B

Answer each of the following questions:

Question 1: Refer to the following graph when answering this question. Note that TTM means trailing twelve months.

Question 1a: What is Pfizer’s payout ratio? Assume the forward (or expected) dividend is equal to the dividend over the Trailing Twelve Month (TTM).

Question 1b: How many Pfizer’s shares exist?

Question 1c: Suppose that Pfizer’s book value of equity is $12.50. Find the expected growth in dividend in percentage (%) denoted by ‘g’. Hint: use the result from part (a) to find g.

Question 1d: What is Pfizer’s required return? Assume the last dividend paid was $1.44, find Pfizer’s share price based on the above information.

Question 1e: Post ex-dividend date assume Pfizer’s initial share price drops by the amount of the forward dividend then it increase by 95% due to good investment projects. Assume the forward dividend is equal to the dividend over the trailing twelve months (TTM) and all other variables remain the same as shown above. What is Pfizer’s EPS?

Question 1f: Post ex-dividend date find the Present Value of Growth Opportunities (PVGO) if the share price remains the same as in part (e).

Question 1g: What percentage of Pfizer’s initial share price was represented by the PVGO?

Question 1h: Assuming that Pfizer’s annual dividend next year increases to $6.60 per share fully franked and the corporate tax rate is 35%, calculate the amount of the franking credit per share.

Question 1i: If your personal marginal tax rate is 55%, calculate the amount of additional personal tax payable on the $6.60 dividend.

Question 2: Data about a company and the financial markets are given below. All rates are effective annual rates. Assume a classical tax system.

• The company has 1 million shares with a market value of $2 each. The shares’ expected dividend yield is 4% pa and the growth rate of dividends is expected to be 3% pa in perpetuity. The beta of the company’s equity is 0.75.

• The company is also funded by a 5-year loan with a 6% pa interest rate. The loan is currently worth $3 million.

• The corporate tax rate is 30%.

• Government bonds yield 4% pa and pay a fixed coupon rate of 5% pa.

• The ASX200 market index has a total expected return of 8% pa.

Question 2a: Calculate the company’s debt-to-assets ratio

Question 2b: Calculate the company’s required return on equity (rE).

Question 2c: Calculate the company’s before-tax WACC.

Question 2d: Calculate the company’s after-tax WACC.

Question 2e: Calculate the company’s loan debt beta (BD) based on its interest rate.

Question 2f: Calculate the company’s present value of interest tax shields assuming that the appropriate discount rate for the interest tax shields is the cost of debt and the proportion of debt funding in the company is constant.

Question 2g:

Here are the Net Income (NI) and Cash Flow From Assets (CFFA) equations:

NI = (Rev−COGS−FC−Depr−IntExp).(1−tc) CFFA = NI+Depr−CapEx−ΔNWC+IntExp

Assume the following holds:

• the value of debt (D) is constant through time,

• The cost of debt and the yield on debt are equal and given by rD.

• the appropriate rate to discount interest tax shields is rD.

• IntExp=D.rD

For a firm with debt, what is the formula for the present value of interest tax shields if the tax shields occur in perpetuity? Show your working in detail.

Question 3: An investor holds a portfolio comprising three assets (or stocks) A, B and C. Refer to the below tables to answer the questions that follow. Assume that returns are effective annual rates:

Question 3a: What is the weight of each stock in the portfolio?

Question 3b: What is the expected return of the portfolio?

Question 3c: What is the variance of the portfolio?

Question 3d: What is the standard deviation of the portfolio?

Question 3e: Using the above table find the covariance of the returns between A & B, A & C and B & C?

Question 3f: Which combination of the stocks correlation coefficient will provide the maximum benefit of portfolio diversification? Explain your reasoning.

Question 3g: Assume the betas of stock A, B and C are 1.3, 1.0 and 1.8 respectively. What is the portfolio beta? Is the portfolio more or less risky than the market?

Question 3h: If the proportion of your money invested in stocks A, B and C are, 15%, 80% and 5% respectively, what is the portfolio expected return?