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of Stock

CHAPTER ORIENTATION

This chapter continues the introduction of concepts underlying asset valuation begun in

Chapter 7. We are specifically concerned with valuing preferred stock and common stock.

We also look at the concept of a stockholder’s expected rate of return on an investment.

CHAPTER OUTLINE

I. Preferred Stock

A. Features of preferred stock

1. Owners of preferred stock receive dividends instead of interest.

2. Most preferred stocks are perpetuities (non-maturing).

3. Multiple classes, each having different characteristics, can be issued.

4. Preferred stock has priority over common stock with regard to claims on

assets in the case of bankruptcy.

5. Most preferred stock carries a cumulative feature that requires all past

unpaid preferred stock dividends to be paid before any common stock

dividends are declared.

6. Preferred stock may contain other protective provisions.

7. Preferred stock contains provisions to convert to a predetermined

number of shares of common stock.

8. Retirement features for preferred stock are frequently included.

a. Callable preferred refers to a feature which allows preferred

stock to be called or retired, like a bond.

b. A sinking fund provision requires the firm periodically to set

aside an amount of money for the retirement of its preferred

stock.

252

B. Valuation of preferred stock (Vps):

The value of a preferred stock equals the present value of all future dividends.

If the stock is nonmaturing, where dividends are expected in equal amount each

year in perpetuity, the value may be calculated as follows:

annual dividend D

Vps = =

required rate of return kps

II. Common Stock

A. Features of Common Stock

1. As owners of the corporation, common shareholders have the right to

the residual income and assets after bondholders and preferred

stockholders have been paid.

2. Common stock shareholders are generally the only security holders with

the right to elect the board of directors.

3. Preemptive rights entitle the common shareholder to maintain a

proportionate share of ownership in the firm.

4. Common stock shareholders’ liability as owners of the corporation is

limited to the amount of their investment.

5. Common stock’s value is equal to the present value of all future cash

flows expected to be received by the stockholder.

B. Valuing common stock

1. Dividend valuation model

a. Company growth occurs either by:

(1) The infusion of new capital.

(2) The retention of earnings, which we call internal growth.

The internal growth rate of a firm equals:

Percentage of earnings

Return on equity X retained within the firm

b. Although the bondholder and preferred stockholder are promised

a specific amount each year, the dividend for common stock is

based on the profitability of the firm and the management's

decision either to pay dividends or retain profits for

reinvestment.

c. The common dividend typically increases along with the growth

in corporate earnings.

d. The earnings growth of a firm should be reflected in a higher

price for the firm's stock.

253

e. In finding the value of a common stock (Vcs), we should

discount all future expected dividends (Dl, D2, D3, D∞) to the

present at the required rate of return for the stockholder (kc).

That is:

D1 D2 D∞

Vcs = + +...+

(1 + k cs )

1

(1 + k cs ) 2

(1 + k cs )∞

f. If we assume that the amount of dividend is increasing by a

constant growth rate each year; that is, the dividend in year t, Dt,

equals:

Dt = D0 (l + g)t

where g = the growth rate

D0 = the most recent dividend payment

If the growth rate, g, is the same each year and is less than the

required rate of return, kcs, the valuation equation for common

stock can be reduced to

D1 D0 (1 + g)

Vcs = =

kcs - g kcs - g

2. Free cash flow valuation model

a. Free cash flow valuation defines the value of the firm to be the

present value of its expected future cash flows. More value is

equal to the present value of its “free cash flows” discounted at

the company’s cost of capital.

the sum of the present values of the free cash flows for a

“planning period” plus the present value of the cash flows

beyond the planning horizon (i.e., the residual value), i.e.,

Intrinsic or

Planning Period

Economic Value = Present value Cash Flows

of the Firm

Residual

+ Present value Value

c. The present value, PV, of the free cash flows (FCFt) for the

planning period (year one through year T) is computed as

follows:

254

T

FCFt

PV = ∑ (1 + k)

t =1

t

T+1 can be calculated as follows:

FCFT+1

RV =

T k -g

rate, g (which must be less than k) forever.

f. We then find the present value of the residual value as follows:

RVT

RV0 =

(1 + k)T

free cash flows and the residual cash flows can be expressed as

follows:

T

FCFt RVT

PV = ∑ (1 + k)

t =1

t

+

(1 + k) T

A. The shareholder's expected rate of return is of great interest to financial

mangers because it tells about the investor’s expectations.

B. Preferred stockholder's expected rate of return.

If we know the market price of a preferred stock and the amount of the

dividends to be received, the expected rate of return from the investment can be

determined as follows:

annual dividend

expected rate of return =

market price of the stock

or

D

k ps =

Pps

1. The expected rate of return for common stock can be calculated from

the valuation equations discussed earlier.

255

2. Assuming that dividends are increasing at a constant annual growth rate

(g), we can show that the expected rate of return for common stock,

k cs is

dividend in year 1 growth

k cs = market price + rate

D1

= + g

Pcs

Since dividend ÷ price is the "dividend yield," the

dividend growth

Expected rate of return = yield + rate

ANSWERS TO

END-OF-CHAPTER QUESTIONS

8-1. Preferred stock is many times referred to as a hybrid security. This is because

preferred stock has many characteristics of both common stock and bonds. It has

characteristics of common stock: no fixed maturity date, the nonpayment of dividends

does not force bankruptcy, and the nondeductibility of dividends for tax purposes. But

it is like bonds because the dividends are fixed in amount like interest payments. From

the point of view of the preferred stock shareholder, this is not the most delightful

combination. On one hand, the dividends are limited as with bonds, but the security of

forced payment by the threat of bankruptcy is not there. Thus, from the point of view

of the investor, the worst features of common stock and bonds are combined.

8-2. To a certain extent, preferred stock dividends can be thought of as a liability. The

major difference between preferred dividends in arrears and normal liabilities is that

nonpayment of them cannot force the firm into bankruptcy. However, since the goal of

the firm is shareholder wealth maximization, which involves getting money to the

shareholders (dividends), preferred arrearages do provide an effective block for the

goal of the firm.

8-3. A cumulative feature requires all past unpaid preferred stock dividends be paid before

any common stock dividends are declared. A stockholder would like preferred stock to

have a cumulative dividend feature because without it there would be no reason why

preferred stock dividends would not be omitted or passed when common stock

dividends were passed. Since preferred stock does not have the dividend enforcement

power of interest from bonds, the cumulative feature is necessary to protect the rights

of preferred stockholders.

256

Other protective features serve generally to allow for voting rights in the event of

nonpayment of dividends, or they restrict the payment of common stock dividend if

sinking-fund payments are not met or if the firm is in financial difficulty. In effect, the

protective features included with preferred stock are similar to the restrictive provisions

included with long-term debt.

8-4. Convertibility allows a preferred stockholder to convert or exchange preferred stock for

shares of common stock at a predetermined exchange rate. This option gives preferred

stockholders more freedom in investment decisions by allowing them to convert into

common stock at their discretion.

Preferred stock may be callable by the issuer so that in the event interest rates decline

and cheaper funding becomes available, then the stock may be called and new

securities may be issued at a lower cost. To agree to the call feature, the investor will

require a slightly higher rate of return.

8-5. Both values are based on future cash flows to be received by stockholders. Preferred

stock typically has a predetermined constant dividend. For common stock, the

dividend is based on profitability of the firm and on management’s decision to pay

dividends or to retain the profits for reinvestment purposes. Thus, the growth of future

dividends is a prime distinguishing feature of common stock.

8-6. The expected rate of return is the rate of return that may be expected from purchasing a

security at the prevailing market price. Thus, the expected rate of return is the rate that

equates future cash flows with the actual selling price of the security in the market.

8-7. The expected rate of return is the discount rate that equates the present value of future

expected cash flows with the value of the security.

8-8. The two types of return include dividend income and capital gains. The dividend

income for common stockholders differs from preferred stockholders, in that no

specified dividend amount is to be received. However, the common stockholders are

permitted to participate in the growth of the company. As a result of this growth, their

second source of return, that of price appreciation, results.

257

SOLUTIONS TO

END-OF-CHAPTER PROBLEMS

8-1.

A B

You would choose stock A, which has an expected rare of return greater than your

required rate of return—12.86 percent versus 12 percent. On the other hand, stock B’s

expected rate of return does not meet your required rate of return.

Thus:

growth rate

Retention rate =

return on equity

.07

= = .58 or 58%

.12

Dividend

b. Expected rate of return = + growth rate

Selling Price

$3.25(1+ .0633)

= + 0.0633 = 01496 or 14.96%

$40

c. Since he stock has an expected rate of return of 14.96 percent, which is greater

than you 13-percent required rate of return, you should invest.

8-4. Value (Vcs) =

(Required Rate - Growth Rate)

$1 + growth rate

$32.50 =

.12 − growth rate

258

Solving for the growth rate, g:

$32.50(0.12 –g) = $1 + g,

$3.90 - $32.50g = $1 + g

$2.90 = $33.50g

g = 0.0866 or 8.66%

8-5. Value(Vps) =

required rate of return

.14 x $100

=

.12

$14

=

.12

= $116.67

Dividend $1.95

k ps = = = or .0463, or 4.63%

Selling Price $42.16

Dividend $3.40

8-7. a. Expected return = = = .085 = 8.5%

Price $40

b. Given your 8 percent required rate of return, the stock is worth $42.50 to you

Dividend $3.40

Value = = = $42.50

Required Rate of Return .08

Since the expected rate of return (8.5%) is greater than your required rate of

return (8%) or since the current market price, ($40) is less than $42.50, the stock

is undervalued and you should buy.

8-8. Value (Vcs) = +

(1 + Required Rate) (1 + Required Rate)

$6 P1

$50 = +

(1 + .15) (1 + .15)

Rearranging and solving for P1:

P1 = $50 (1.15) - $6

P1 = $51.50

The stock would have to increase $1.50 ($51.50 - $50) or 3 percent ($1.50/$50) to earn

a 15% rate of return.

259

Expected rate Dividend in Year 1 growth

8-9. a. (k cs ) = + rate

of return Market Price

$2.00

k cs = + .10 = .1889

$22.50

k cs = 18.9%

$2.00

b. Vcs = = $28.57

.17 - .10

Yes, purchase the stock. The expected return is greater than your required rate

of return. Also, the stock is selling for only $22.50, while it is worth $28.57 to

you.

8-10. Value (Vcs) =

(Required Rate - Growth Rate)

$3.50(1 + .05)

Vcs =

.20 - .05

Vcs = $24.50

= (18%) (40%) = 7.2%

Last Year Dividend (1 + Growth Rate)

= + Growth Rate

Price

_ 2.94(1.095)

k cs = + 0.095 = 0.193

$32.84

_

k cs = 19.3%

8-13. Value (Vcs) = +

(1 + Required Rate) (1 + Required Rate)

$1.85 $42.50

Vcs = +

(1.11) (1.11)

Vcs = $39.96

260

8-14. If the expected rate of return is represented by k cs :

Dividend in year 1 Price in year 1

Current Price = +

(1 + k cs ) (1 + k cs )

Dividend in Year 1 + Price in Year 1

k cs = - 1

Current Price

$2.84 + $48.00

k cs = - 1 = 0.1823

$43.00

k cs = 18.23%

Dividend $3.60

8-15. a. k ps = = = 10.91%

Price $33.00

Dividend $3.60

b. Value (Vps) = = = $36

Required Rate of Return 0.10

c. The investor's required rate of return (10 percent) is less than the expected rate

of return for the investment (10.91 percent). Also, the value of the stock to the

investor ($36) exceeds the existing market price ($33). So buy the stock.

8-16. a. Expected Rate of Return = + Rate

Market Price

$1.32(1.08)

= + 0.08 = 0.1407

$23.50

= 14.07%

Dividend in Year 1

b. Investor's Value =

Required Rate of Return - Growth Rate

$1.32(1.08)

=

0.105 - 0.08

= $57.02

c. Yes, the expected rate of return is greater than your required rate of return (14

percent versus 10.5 percent). Also, your value of the stock ($57.02) is larger

than the current market price ($23.50).

D 6

8-17. Vps = = = $50 per share

k ps .12

261

8-19. (Note: The following solution has been completed using Excel, with the printed solution

being to the nearest dollar. Thus, you may find some rounding errors.)

Most Recent Year's Sales $2,000

Debt $250

Operating Profit Margin 12.0%

Assets/Sales 40.0%

Tax Rate 40.0%

Sales Growth Rates

1-2 years 14.0%

3-5 years 9.0%

Year 6 and Beyond 3.0%

Years 1 2 3 4 5 6

Sales $2,280 $2,599 $2,833 $3,088 $3,366 $3,467

Operating Profits $274 $312 $340 $371 $404 $416

Taxes 109 125 136 148 162 166

Operating Profits After Taxes $164 $187 $204 $222 $242 $250

Investments 112 128 94 102 111 40

Free Cash Flows $52 $59 $110 $120 $131 $209

Present Value Free Cash Flows $47 $49 $83 $82 $81

Shareholder Value:

Present Value of All Cash Flows Years 1-5 $343

Residual Value Year 5 $2,989

Present Value Residual Value 1,856

Firm Value $2,199

Debt 250

Shareholder Value $1,949

Where the present value of all cash flows years 1-5 is the sum of the present value of the

individual cash flows for years one through five, and the residual value in year 5 is equal to:

= $209/(0.10 – 0.03) = $2,986

And the present value of the residual value = residual value in year 5/(1 + cost of capital)5

= $2,989/(1+0.10)5 = $1,856

262

SOLUTION TO MINI CASE

Bond:

10 N

6 I/Y

76.25 PMT

1000 FV

CPT PV → ANSWER -1119.60

10

$76.25 $1,000

Vb = ∑ (1 + .06) t

+

(1 + .06)10

t =1

= $76.25(7.3601) + $1,000(.55839)

= $561.21 + $558.39

= $1,119.60

Preferred Stock:

∞ $2.8125

Vps = ∑

t =1 (1 + .06)

t

However, since the dividend is a constant amount each year with no maturity

date (infinity), the equation can be reduced to

Dividend

Vps =

Required Rate of Return

$2.8125

=

.07

= $40.18

Common Stock:

Step 1: Estimate Growth Rate

263

Company's earnings have increased from $2.40 to $4.48 in five years. What

annual compound growth rate would cause an investment to increase in five

years?

Growth Rate (g) = (4.48/2.40)^(1/5)-1

= 13.30%

Step 2: Solve for Value

∞ $2.10(1 + .133) t

Vcs = ∑

t =1 (1 + .15) t

If the percent growth rate (g) is assumed constant, the equation may be reduced

to

Vcs =

Required Rate of Return - Growth Rate

D1

=

kcs - g

$2.10(1 + .133)

=

.15 − .133

2.3793

=

.017

= $139.96

2. Your Value Selling Price

Bond $1,119.61 $986.00

Preferred Stock 40.18 39.00

Common Stock 139.96 80.00

You would choose to invest in all the securities. They are all selling for a price lower

than the value of investment based on your required rate of return.

3. Common Stock:

Growth Rate (g) = 13.3% - 3% = 10.3%

Vcs =

Required Rate of Return - Growth Rate

D1

=

kcs - g

264

$2.10(1 + .103)

=

.15 − .103

2.3163

=

.047

= $49.28

Your Value Selling Price

Common Stock 49.28 80.00

You would prefer not to buy the Emerson Electric stock because its selling price is

higher than the investment based on your required rate of return.

4. Bond:

10

$76.25 $1,000

$986 = ∑

t =1 (1 + k b ) t

+

(1 + k b )10

10 N

986 +/- PV

76.25 PMT

1000 FV

CPT I/Y → ANSWER 7.83

Preferred Stock:

Dividend

Vps =

Required Rate of Return

2.8125

Required Rate of Return =

39

= 7.21%

Common Stock:

Vcs =

Required Rate of Return - Growth Rate

$2.10(1 + .133)

80 =

k − .133

2.3793

k = + .133

80

= 16.27%

265

ALTERNATIVE PROBLEMS WITH SOLUTIONS

ALTERNATIVE PROBLEMS

8-1A. (Preferred Stock Valuation) What is the value of a preferred stock where the dividend

rate is 16 percent on a $100 par value? The appropriate discount rate for a stock of this

risk level is 12 percent.

8-2A. (Preferred Stockholder Expected Return) Shewmaker’s preferred stock is selling for

$55.16 and pays $2.35 in dividends. What is your expected rate of return if you

purchase the security at the market price?

8-3A. (Preferred Stockholder Expected Return) You own 250 shares of McCormick

Resources’ preferred stock, which currently sells for $38.50 per share and pays annual

dividends of $3.25 per share.

a. What is your expected return?

b. If you require an 8 percent return, given the current price, should you sell or

buy more stock?

8-4A. (Common Stock Valuation) You intend to purchase Bama, Inc., common stock at

$52.75 per share, hold it one year, and sell after a dividend of $6.50 is paid. How much

will the stock price have to appreciate if your required rate of return is 16 percent?

8-5A. (Common Stockholder Expected Return) Blackburn & Smith’s common stock currently

sells for $23 per share. The company’s executives anticipate a constant growth rate of

10.5 percent and an end-of-year dividend of $2.50.

a. What is the expected rate of return if you buy the stock for $23?

b. If you require a 17 percent return, should you purchase the stock?

8-6A. (Common Stock Valuation) Gilliland Motor, Inc., paid a $3.75 dividend last year. At a

constant growth rate of 6 percent, what is the value of the common stock if the

investors require a 20 percent rate of return?

8-7A. (Measuring Growth) Given that a firm’s return on equity is 24 percent and

management plans to retain 60 percent of earnings for investment purposes, what will

be the firm’s growth rate?

8-8A. (Common Stockholder Expected Return) The common stock of Bouncy-Bob Moore

Co. is selling for $33.84. The stock recently paid dividends of $3 per share and has a

projected constant growth rate of 8.5 percent. If you purchase the stock at the market

price, what is your expected rate of return?

8-9A. (Common Stock Valuation) Honeybee common stock is expected to pay $1.85 in

dividends next year, and the market price is projected to be $40 by year end. If the

investor’s required rate of return is 12 percent, what is the current value of the stock?

8-10A. (Common Stock Expected Rate of Return) The market price for M. Simpson & Co.’s

common stock is $44. The price at the end of one year is expected to be $47, and

dividends for next year should be $2. What is the expected rate of return?

266

8-11A. (Preferred Stock Valuation) Gree’s preferred stock is selling for $35 in the market and

pays a $4 annual dividend.

a. What is the expected rate of return of the stock?

b. If an investor’s required rate of return is 10 percent, what is the value of the

stock for the investor?

c. Should the investor acquire the stock?

8-12A. (Common Stock Valuation) The common stock of KPD paid $1 in dividends last year.

Dividends are expected to grow at an 8 percent annual rate for an indefinite number of

years.

a. If KPD’s current market price is $25, what is the stock’s expected rate of

return?

b. If your required rate of return is 11 percent, what is the value of the stock for

you?

c. Should you make the investment?

8-13A. (Comprehensive Problem in Valuing Securities) You are considering three

investments. The first is a bond that is selling in the market at $1,200. The bond has a

$1,000 par value, pays interest at 14 percent, and is scheduled to mature in 12 years.

For the bonds of this risk class you believe that a 12 percent rate of return should be

required. The second investment that you are analyzing is a preferred stock ($100 par

value) that sells for $80 and pays an annual dividend of $12. Your required rate of

return for this stock is 14 percent. The last investment is a common stock ($35 par

value) that recently paid a $3 dividend. The firm’s earnings per share have increased

from $4 to $8 in 10 years, which also reflects the expected growth in dividends per

share for the indefinite future. The stock is selling for $25, and you think a reasonable

required rate of return for the stock is 20 percent.

a. Calculate the value of each security based on your required rate of return.

b. Which investment(s) should you accept? Why?

c. 1. If your required rates of return changed to 14 percent for the bond, 16

percent for the preferred stock, and 18 percent for the common stock,

how would your answers change to parts (a) and (b)?

2. Assuming again that your required rate of return for the common stock

is 20 percent, but the anticipated constant growth rate changes to 12

percent, would your answers to parts (a) and (b) be different?

267

SOLUTIONS TO ALTERNATIVE PROBLEMS

.16 x $100

8-1A. Value(Vps) =

.12

$16

=

.12

= $133.33

_ Dividend $2.35

k ps = Selling Price = $55.16 = 4.26%

Dividend $3.25

8-3A. a. Expected return = = = .0844 = 8.44%

Price $38.50

b. Given your 8 percent required rate of return, the stock is worth $40.62 to you

Dividend $3.25

Value = = = $40.625

Required Rate of Return .08

Since the expected rate of return (8.44%) is greater than your required rate of

return (8%) or since the current market price ($38.50) is less than $40.62, the

stock is undervalued and you should buy.

8-4A. Value ( Vcs) = +

(1 + Required Rate) (1 + Required Rate)

$6.50 P1

$52.75 = +

(1 + .16) (1 + .16)

P1 = $54.69

The stock would have to increase $1.94 ($54.69 - $52.75) or 3.6 percent ($1.94/$52.75)

to earn a 16% rate of return.

268

_ Dividend in Year 1 growth

Expected

8-5A. a. ( k cs) = + rate

rate of return Market Price

_ $2.50

k cs = $23.00 + .105 = .2137

_

k cs = 21.37%

$2.50

b. Vcs = = $38.46

.17 - .105

The expected rate of return exceeds your required rate of return, which means

that the value of the security to you is greater than the current market price.

Thus, you should buy the stock.

8-6A. Value (Vcs) =

(Required Rate - Growth Rate)

$3.75(1 + .06)

Vcs =

.20 - .06

Vcs = $28.39

_

8-8A. Expected Rate of Return ( k cs) =

+ Growth Rate

Price

_ $3.00(1.085)

k cs = + 0.085 = 0.181 = 18.1%

$33.84

8-9A. Value (Vcs) = +

(1 + Required Rate) (1 + Required Rate)

$1.85 $40.00

Vcs = +

(1.12) (1.12)

Vcs = $37.37

269

_

8-10A If the expected rate of return is represented by k cs:

Current Price = +

(1 + k cs ) (1 + k cs )

k cs = - 1

Current Price

$2.00 + $47.00

k cs = - 1 = 0.1136

$44.00

k cs = 11.36%

Dividend $4.00

8-11A. a. k ps = = = 11.43%

Price $35.00

Dividend $4.00

b. Value (Vps ) = = = $40

Required Rate of Return 0.10

c. The investor's required rate of return (10 percent) is less than the expected rate

of return for the investment (11.43 percent). Also, the value of the stock to the

investor ($40) exceeds the existing market price ($35). You should buy the

stock.

8-12A. a. Expected Rate of Return = + Rate

Market Price

$1.00(1.08)

= + 0.08 = 0.1232

$25.00

= 12.32%

Dividend in Year 1

b. Investor's Value =

Required Rate of Return - Growth Rate

$1.00(1.08)

=

0.11 - 0.08

= $36.00

c. Yes, the expected rate of return is greater than your required rate of return

(12.32 percent versus 11 percent). Also, your value of the stock ($36.00) is

larger than the current market price ($25.00).

270

8-13A. a. Value (Vb) based upon your required rate of return:

Bond:

12 $140 $1,000

Vb = ∑ (1 + .12) t

+

(1 + .12)12

t =1

= $140(6.194) + $1,000(.257)

= $867.16 + $257

= $1,124.16

Preferred Stock:

∞ $12

Vps = ∑

t = 1 (1 + .14)

t

However, since the dividend is a constant amount each year with no maturity

date (infinity), the equation can be reduced to

Dividend

Vps =

Required Rate of Return

$12

=

.14

= $85.71

Common Stock:

Company's earnings have doubled ($4 to $8) in ten years. What annual

compound growth rate would cause an investment to double in ten years?

Looking in Appendix B (Compound sum of $1) an interest factor of 2.000 for

ten years is closest to seven percent (1.967). Thus, at about seven percent,

money would double in ten years. (The same conclusion could have been

reached by using Appendix D but by using a .500 present value interest factor.)

∞ $3(1 + .07)t

Vcs = ∑

t = 1 (1 + .20)

t

271

If the seven percent growth rate (g) is assumed constant, the equation may be

reduced to

Vcs =

Required Rate of Return - Growth Rate

D1

=

kcs - g

$3(1 + .07)

=

.20 - .07

$3.21

=

.20 - .07

= $24.69

b. Your Value Selling Price

Bond $1,124.16 $1,200.00

Preferred Stock 85.71 80.00

Common Stock 24.69 25.00

Buy only the Preferred stock; it is the only investment in which the market

price is less than the value to you.

c. (1) Bond:

12 $140 $1000

Vb = ∑ (1 + .14) t

+

(1 + .14)12

t =1

= $140(5.660) + $1,000(.2076)

= $792.40 + $207.60

= $1,000.00

Preferred Stock:

$12

Vps =

.16

= $75.00

272

Do not buy. Your value is less than what you would have to pay for the

stock.

Common Stock:

$3.21

Vcs =

.18 - .07

= $29.18

Buy. Your value is greater than what you would have to pay for the

stock.

$3(1 + .12)

Vcs =

.20 - .12

$3.36

= = $42

.08

now worth more to you ($42) than you would have to pay for it ($25)--

assuming that the selling price did not increase also.

273

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