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Portfolio managers are frequently paid a proportion of the funds under management. Suppose you manage a
$101 million equity portfolio offering a dividend yield (DIV1/ P0) of 5.1%. Dividends and portfolio value are
expected to grow at a constant rate. Your annual fee for managing this portfolio is .51% of portfolio value and is
calculated at the end of each year.

a. Assuming that you will continue to manage the portfolio from now to eternity, what is the present value of the
management contract?

Present value $

b. What would the contract value be if you invested in stocks with a 4.1% yield?

Contract value $

Company Q’s current return on equity (ROE) is 13%. The firm pays out 45 percent of its earnings as cash
dividends. (payout ratio = .45). Current book value per share is $68. Book value per share will grow as Q
reinvests earnings.

Assume that the ROE and payout ratio stay constant for the next four years. After that, competition forces ROE
down to 11.0% and the payout ratio increases to .90. The cost of capital is 11.0%.

a. What are Q’s EPS and dividends in years 1, 2, 3, 4, and 5?

Year EPS Dividends

1 $ $
2 $ $
3 $ $
4 $ $
5 $ $

b. What is Q’s stock worth per share?

Stock worth per share $


Pharmecology just paid an annual dividend of $1.40 per share. It’s a mature company, but future EPS and
dividends are expected to grow with inflation, which is forecasted at 3.00% per year. The nominal cost of capital
is 9.75%.

a. What is Pharmecology’s current stock price?

Current stock price $

b. What would be Pharmecology’s current stock price using forecasted real dividends and a real discount rate?

Current stock price $


Company X is expected to pay an end-of-year dividend of $3.50 a share. After the dividend its stock is expected
to sell at $80. If the market capitalization rate is 13%, what is the current stock price?

Stock price $


Company Z's earnings and dividends per share are expected to grow indefinitely by 3% a year. If next year's
dividend is $8 and the market capitalization rate is 10%, what is the current stock price?

Stock price $

Mexican Motors’ market cap is 300 billion pesos. Next year’s free cash flow is 8.7 billion pesos. Security
analysts are forecasting that free cash flow will grow by 7.7% per year for the next five years.

a. Assume that the 7.7% growth rate is expected to continue forever. What rate of return are investors

Rate of return %

b-1. Mexican Motors has generally earned about 11% on book equity (ROE = 11%) and reinvested 50% of
earnings. The remaining 50% of earnings has gone to free cash flow. Suppose the company maintains the
same ROE and investment rate for the long run. What will be the growth rate of earnings?

Growth rate %

b-2. What would be the rate of return?

Rate of return %

Permian Partners (PP) produces from aging oil fields in west Texas. Production is 1.87 million barrels per year
in 2016, but production is declining at 9% per year for the foreseeable future. Costs of production,
transportation, and administration add up to $25.70 per barrel. The average oil price was $65.70 per barrel in

PP has 7.7 million shares outstanding. The cost of capital is 11%. All of PP’s net income is distributed as
dividends. For simplicity, assume that the company will stay in business forever and that costs per barrel are
constant at $25.70. Also, ignore taxes.

a. Assume that oil prices are expected to fall to $60.70 per barrel in 2017, $55.70 per barrel in 2018, and $50.70
per barrel in 2019. After 2019, assume a long-term trend of oil-price increases at 7% per year. What is the
ending 2016 value of one PP share?

Share value2016 $

b-1. What is PP’s EPS/P ratio?

EPS/P ratio

b-2. Is it equal to the 11% cost of capital?