Warning: Please don’t go ahead if you haven’t done Schweser Volume 1 Exam 2 AM. Anyways, I have two questions on questions 13-18 relating to O’Connor Textiles, Part 1 (Pg.82). 1) Regarding question 14, The value of one share of O’Connor stock in early 2008 using the two-stage divident discount model is closest to: a) 58.55 b) 61.78 c) 64.54 d) 67.12 I did’t get the answer. This is what Schweser says: The value of the stock in early 2008 is the present value of the future dividends. After 2010, dividends are expected to grow at the rate of 4%. The dividend that begins the constantly growing perpetuity is $2.63 × 1.04 = $2.74. The appropriate discount rate is the cost of equity of 7.2% from Question 13. Note that for the third cash flow, we add the third dividend ($2.63) to the present value of the constantly growing perpetuity that begins in the fourth year = $2.74 / (0.08 – 0.04) = $68.50. This is valid since they both occur at the same point in time (i.e., at the end of the third year). Using a financial calculator we can estimate the value of one share of O’Connor stock as follows: CFO = 0; C01 = $2.13; C02 = $2.36; C03 = $2.63 + $68.50 = $71.13; I = 7.2; CPT NPV = $61.78 Where the **** are they getting the 0.08 from??? I am tearing my hair out. I thought u divide by r-g and r is the 7.2%…right? Ok, the second one: It’s regarding adjusted betas. From SS18, LOS68h, Alpha0 = 1-Alpha1. They tell us the adjusted beta forecast will move towards 1 more quickly for larger values of Alpha1 (as Alpha1 approaches a value of 1). Fair enough. Then they give us an example: 2/3+1/3*Bt-1 with a historical beta of 2. Do the math and we get 1.33. Fair enough. But then, I switched the numbers and tried doing 1/3+2/3*Bt-1. Now we have Alpha1 closer to 1. (2/3=.667). But we ended up getting an adjusted beta of 1.66 when do the math. How is this possible? Aren’t we supposed to get a beta of less than 1.33 ??? Please help…
i believe schweser released an errata for your first question… it was something like they used .08 for required return or something…