MM Proposition 2: McLaren Corp is financed entirely by common stock and has a beta of 1.0. The firm is expected to generate a level, perpetual stream of earnings and dividends. The stock has a price-earnings ratio of 8 and a cost of equity of 12.5%. The company’s stock is selling for $50. The firm decides to repurchase half its shares and substitute an equal value of debt (issue debt and use the proceeds to buy back shares). The debt is risk0free, with an interest rate of 5%. The company is exempt from corporate income taxes. Assuming MM are correct, calculate the following items after refinancing. a. The cost of equity. b. The overall cost of capital. c. The price-earnings ratio. d. The stock price. e. The stock’s beta.
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
MM Proposition 2: McLaren Corp is financed entirely by common stock and has a beta of
1.0. The firm is expected to generate a level, perpetual stream of earnings and dividends.
The stock has a price-earnings ratio of 8 and a
stock is selling for $50. The firm decides to repurchase half its shares and substitute an
equal value of debt (issue debt and use the proceeds to buy back shares). The debt is
risk0free, with an interest rate of 5%. The company is exempt from corporate income
taxes. Assuming MM are correct, calculate the following items after refinancing.
a. The cost of equity.
b. The overall cost of capital.
c. The price-earnings ratio.
d. The stock price.
e. The stock’s beta.
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