FIN 420 EXAM 3 MERGERS AND
ACQUISITIONS VALUATION MODELS AND
DEAL STRUCTURING QUESTIONS AND
SOLUTIONS
●● At stock split is a non-cash event in which the number of stocks are
increased to reduce the per share price. For example, a 2-for-1 split on a
$50 priced stock would translate to two shares for $25 each.
Answer: - The market value of the company is unchanged
- The earnings per share decreases (more shares of stock)
- The P/E ratio remains the same
- A lower stock price gives a broader audience a chance to purchase the
stock
- There is no realized taxable income
- The tax basis per share is adjusted downward
●● constant growth dividend discount model (Gordon growth model)
Answer: used to compute a stock's intrinsic value. used w/ dividends
growing at a constant rate to perpetuity. this model is the assumption it
goes into perpetuity
●● No growth model
Answer: preferred stock that have a fixed dividend rate and no maturity.
,●● Implies stock value higher (V ^) if:
Answer: Larger dividend per share (D1 ↑) | Lower expected return rate (r
↓) | Higher expected growth rate of dividends (g ↑) | This model works if
r>g
●● The Black-Scholes option valuation model estimates the value of a
European option by using a mathematical model that incorporates five
factors.
Answer: •The current underlying stock price on which the option is
written
•The option's exercise price
•The time to expiration of the option
•The risk-free rate of return
•The volatility (standard deviation) of the security's returns
●● Differentiate a cash dividend from a non-cash dividend
Answer: A stock dividend is a non-cash payment. It is a payment to
shareholders of record in the form of stock.- The market value of the
company is unchanged
- The stock price per share decreases
- Earnings per share decreases (more shares of stock)
- The P/E ratio remains the same
- There is no realized taxable income
, - The tax basis per share is adjusted downward
●● Compute the intrinsic value of preferred stock using the no-growth
dividend discount model
Answer: V = D/r. V = intrinsic value of the stock D = fixed dividend r =
investor's required rate of return
●● Compute the intrinsic value of common stock using the constant
growth dividend discount
Answer: Constant Growth Dividend Discount Model - XYZ stock paid a
dividend of $4.81 this past year. The dividend is expected to increase by
4% annually and investors who own stock in similar firms require a
return of 18%. What is the market value of the firm's stock?
G=4%, R=18%; D1 --> 1.04 | D1 = D0 (1+g)^1 = 4.81(1.04) = 5.00;
5/(.18-.04) = 35.71
●● Compute the intrinsic value of common stock using a multi-state
dividend discount model
Answer: Multi-state Growth Dividend Discount Model Relative Value
Methods (didn't pay dividend, had to use this) - Price-to-Earnings (P/E)
Ratio
●● Compute the value of stock using a non-dividend valuation model:
P/E ratio, PEG ratio, P/Sales
ACQUISITIONS VALUATION MODELS AND
DEAL STRUCTURING QUESTIONS AND
SOLUTIONS
●● At stock split is a non-cash event in which the number of stocks are
increased to reduce the per share price. For example, a 2-for-1 split on a
$50 priced stock would translate to two shares for $25 each.
Answer: - The market value of the company is unchanged
- The earnings per share decreases (more shares of stock)
- The P/E ratio remains the same
- A lower stock price gives a broader audience a chance to purchase the
stock
- There is no realized taxable income
- The tax basis per share is adjusted downward
●● constant growth dividend discount model (Gordon growth model)
Answer: used to compute a stock's intrinsic value. used w/ dividends
growing at a constant rate to perpetuity. this model is the assumption it
goes into perpetuity
●● No growth model
Answer: preferred stock that have a fixed dividend rate and no maturity.
,●● Implies stock value higher (V ^) if:
Answer: Larger dividend per share (D1 ↑) | Lower expected return rate (r
↓) | Higher expected growth rate of dividends (g ↑) | This model works if
r>g
●● The Black-Scholes option valuation model estimates the value of a
European option by using a mathematical model that incorporates five
factors.
Answer: •The current underlying stock price on which the option is
written
•The option's exercise price
•The time to expiration of the option
•The risk-free rate of return
•The volatility (standard deviation) of the security's returns
●● Differentiate a cash dividend from a non-cash dividend
Answer: A stock dividend is a non-cash payment. It is a payment to
shareholders of record in the form of stock.- The market value of the
company is unchanged
- The stock price per share decreases
- Earnings per share decreases (more shares of stock)
- The P/E ratio remains the same
- There is no realized taxable income
, - The tax basis per share is adjusted downward
●● Compute the intrinsic value of preferred stock using the no-growth
dividend discount model
Answer: V = D/r. V = intrinsic value of the stock D = fixed dividend r =
investor's required rate of return
●● Compute the intrinsic value of common stock using the constant
growth dividend discount
Answer: Constant Growth Dividend Discount Model - XYZ stock paid a
dividend of $4.81 this past year. The dividend is expected to increase by
4% annually and investors who own stock in similar firms require a
return of 18%. What is the market value of the firm's stock?
G=4%, R=18%; D1 --> 1.04 | D1 = D0 (1+g)^1 = 4.81(1.04) = 5.00;
5/(.18-.04) = 35.71
●● Compute the intrinsic value of common stock using a multi-state
dividend discount model
Answer: Multi-state Growth Dividend Discount Model Relative Value
Methods (didn't pay dividend, had to use this) - Price-to-Earnings (P/E)
Ratio
●● Compute the value of stock using a non-dividend valuation model:
P/E ratio, PEG ratio, P/Sales
