Problems

1. Anderson Motors, Inc. has just set the company dividend policy at $0.50 per year.
The company plans on being in business forever. What is the price of this stock if
a. an investor wants a 5% return?
b. an investor wants an 8% return?
c. an investor wants a 10% return?
d. an investor wants a 13% return?
e. an investor wants a 20% return?

ANSWER
Use the constant dividend infinite dividend stream model:

Price = Dividend / r

a. Price = $0.50 / 0.05 = $10.00

b. Price = $0.50 / 0.08 = $6.25
c. Price = $0.50 / 0.10 = $5.00
d. Price = $0.50 / 0.13 = $3.85
e. Price = $0.50 / 0.20 = $2.50

2. Diettreich Electronics wants its shareholders to earn a 15% return on their investment
in the company. At what price would the stock need to be priced today if Diettreich
Electronics had a
a. $0.25 constant annual dividend forever?
b. $1.00 constant annual dividend forever?
c. $1.75 constant annual dividend forever?
d. $2.50 constant annual dividend forever?

ANSWER
Use the constant dividend infinite dividend stream model:

Price = Dividend / r

a. Price = $0.25 / 0.15 = $1.67

b. Price = $1.00 / 0.15 = $6.67
c. Price = $1.75 / 0.15 = $11.67
d. Price = $2.50 / 0.15 = $16.67

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181Brooks Financial Management: Core Concepts, 3e

3. Singing Fish Fine Foods has a current annual cash dividend policy of $2.25. The price
of the stock is set to yield a 12% return. What is the price of this stock if the dividend
will be paid
a. for 10 years?

b. for 15 years?

c. for 40 years?

d. for 60 years?

e. for 100 years?

f. forever?

ANSWER
Use the finite constant dividend model except with f (use infinite constant dividend
model)

Price = Dividend×(1 – 1/(1+r)n) / r

a. Price = $2.25 × (1 – 1/(1.12)10 / 0.12 = $2.25×5.6502 = $12.71

b. Price = $2.25×(1 – 1/(1.12)15 / 0.12 = $2.25×6.8109 = $15.32
c. Price = $2.25×(1 – 1/(1.12)40 / 0.12 = $2.25×8.2438 = $18.54
d. Price = $2.25×(1 – 1/(1.12)60 / 0.12 = $2.25×8.3240 = $18.73
e. Price = $2.25×(1 – 1/(1.12)100 / 0.12 = $2.25×8.3332 = $18.75
f. Price = $2.25 / 0.12 = $18.75

4. Pfender Guitars has a current annual cash dividend policy of $4.00. The price of the
stock is set to yield an 8% return. What is the price of this stock if the dividend will
be paid
a. for 10 years and then a liquidating or final dividend of $25.00?
b. for 15 years and then a liquidating or final dividend of $25.00?
c. for 40 years and then a liquidating or final dividend of $25.00?
d. for 60 years and then a liquidating or final dividend of $25.00?
e. for 100 years and then a liquidating or final dividend of $25.00?
f. forever with no liquidating dividend?

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ANSWER
Use the finite constant dividend model liquidating dividend except with f (use infinite
constant dividend model)

Price = Dividend×(1 – 1/(1+r)n) / r + Liquidating Dividend×(1/(1+r)n)

a. Price = $4.00×(1 – 1/(1.08)10 / 0.08 + $25.00×1/1.0810

= $4.00×6.7101 + $25×0.4632 = $26.84 + $11.58 = $38.42
b. Price = $4.00×(1 – 1/(1.08)15 / 0.08 + $25.00×1/1.0815
= $4.00×8.5595 + $25×0.3152 = $34.24 + $7.88 = $42.12
c. Price = $4.00×(1 – 1/(1.08)40 / 0.08 + $25.00×1/1.0840
= $4.00×11.9246 + $25×0.0460 = $47.70 + $1.15 = $48.85
d. Price = $4.00×(1 – 1/(1.08)60 / 0.08 + $25.00×1/1.0860
= $4.00×12.3766 + $25×0.0099 = $49.51 + $0.24 = $49.75
e. Price = $4.00×(1 – 1/(1.08)100 / 0.08 + $25.00×1/1.08100
= $4.00×12.4943 + $25×0.0005 = $49.98 + $0.01 = $49.99
f. Price = $4.00 / 0.08 = $50.00

5. King Waterbeds has an annual cash dividend policy that raises the dividend each year
by 4%. Last year’s dividend was $0.40 per share. What is the price of this stock if
a. an investor wants a 5% return?
b. an investor wants an 8% return?
c. an investor wants a 10% return?
d. an investor wants a 13% return?
e. an investor wants a 20% return?

ANSWER
Use the constant growth dividend model with an infinite dividend stream:

Price = Last Dividend×(1 + g) / (r – g)

a. Price = $0.40×(1.04) / (0.05 – 0.04) = $0.4160 / 0.01 = $41.60

b. Price = $0.40×(1.04) / (0.08 – 0.04) = $0.4160 / 0.04 = $10.40
c. Price = $0.40×(1.04) / (0.10 – 0.04) = $0.4160 / 0.06 = $6.93
d. Price = $0.40×(1.04) / (0.13 – 0.04) = $0.4160 / 0.09 = $4.62
e. Price = $0.40×(1.04) / (0.20 – 0.04) = $0.4160 / 0.16 = $2.60

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183Brooks Financial Management: Core Concepts, 3e

6. Seitz Glassware is trying to determine its growth rate for an annual cash dividend.
Last year’s dividend was $0.25 per share. The stock’s target return rate is 10%. What
is the stock’s price if
a. the annual growth rate is 1%?
b. the annual growth rate is 3%?
c. the annual growth rate is 5%?
d. the annual growth rate is 7%?
e. the annual growth rate is 9%?

ANSWER
Use the constant growth dividend model with an infinite dividend stream:

Price = Last Dividend×(1 + g) / (r – g)

a. Price = $0.25×(1.01) / (0.10 – 0.01) = $0.2525 / 0.09 = $2.81

b. Price = $0.25×(1.03) / (0.10 – 0.03) = $0.2575 / 0.07 = $3.68
c. Price = $0.25×(1.05) / (0.10 – 0.05) = $0.2625 / 0.05 = $5.25
d. Price = $0.25×(1.07) / (0.10 – 0.07) = $0.2675 / 0.03 = $8.92
e. Price = $0.25×(1.09) / (0.10 – 0.09) = $0.2725 / 0.01 = $27.25

7. Miles Hardware has an annual cash dividend policy that raises the dividend each year
by 3%. Last year’s dividend was $1.00 per share. Investors want a 15% return on this
stock. What is the stock’s price if
a. the company will be in business for 5 years and not have a liquidating dividend?
b. the company will be in business for 15 years and not have a liquidating dividend?
c. the company will be in business for 25 years and not have a liquidating dividend?
d. the company will be in business for 35 years and not have a liquidating dividend?
e. the company will be in business for 75 years and not have a liquidating dividend?
f. the company will be in business forever?

ANSWER
Use the constant growth dividend model with a finite dividend stream:

Price = Last Dividend×(1 + g) / (r – g)×[1 – ((1+g) / (1+r))n]

a. Price = $1.00×(1.03) / (0.15 – 0.03)×[1 – ((1.03) / (1.15))5]

= $1.03 / 0.12×[1 - 0.5764] = $8.58×[0.4236] = $3.64
b. Price = $1.00×(1.03) / (0.15 – 0.03)×[1 – ((1.03) / (1.15))15]
= $1.03 / 0.12×[1 - 0.1915] = $8.58×[0.8085] = $6.94
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c. Price = $1.00×(1.03) / (0.15 – 0.03)×[1 – ((1.03) / (1.15))25]

= $1.03 / 0.12×[1 - 0.0636] = $8.58×[0.9364] = $8.03
d. Price = $1.00×(1.03) / (0.15 – 0.03)×[1 – ((1.03) / (1.15))35]
= $1.03 / 0.12×[1 - 0.0211] = $8.58×[0.9789] = $8.40
e. Price = $1.00×(1.03) / (0.15 – 0.03)×[1 – ((1.03) / (1.15))75]
= $1.03 / 0.12×[1 - 0.0003] = $8.58×[0.9997] = $8.58
f. Price = $1.00×(1.03) / (0.15 – 0.03) = $1.03 / 0.12 = $8.58

8. Sia Dance Studios has an annual cash dividend policy that raises the dividend each
year by 2%. Last year’s dividend was $3.00 per share. The company will be in
business for forty years with no liquidating dividend. What is the price of this stock if
a. an investor wants a 9% return?
b. an investor wants an 11% return?
c. an investor wants a 13% return?
d. an investor wants a 15% return?
e. an investor wants a 17% return?

ANSWER
Use the constant growth dividend model with a finite dividend stream:

Price = Last Dividend×(1 + g) / (r – g)×[1 – ((1+g) / (1+r))n]

a. Price = $3.00×(1.02) / (0.09 – 0.02)×[1 – ((1.02) / (1.09))40]

= $3.06 / 0.07×[1 - 0.0703] = $43.71×[0.9297] = $40.64
b. Price = $3.00×(1.02) / (0.11 – 0.02)×[1 – ((1.02) / (1.11))40]
= $3.06 / 0.09×[1 - 0.0340] = $34.00×[0.9660] = $32.85
c. Price = $3.00×(1.02) / (0.13 – 0.02)×[1 – ((1.02) / (1.13))40]
= $3.06 / 0.11×[1 - 0.0166] = $27.82×[0.9834] = $27.35
d. Price = $3.00×(1.02) / (0.15 – 0.02)×[1 – ((1.02) / (1.15))40]
= $3.06 / 0.13×[1 - 0.0082] = $23.54×[0.9918] = $23.35
e. Price = $3.00×(1.02) / (0.17 – 0.02)×[1 – ((1.02) / (1.17))40]
= $3.06 / 0.15×[1 - 0.0041] = $20.40×[0.9959] = $20.32

9. Fey Fashions expects the following dividend pattern over the next seven years:

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

$1.00 $1.10 $1.21 $1.33 $1.46 $1.61 $1.77

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185Brooks Financial Management: Core Concepts, 3e

Then the company will have a constant dividend of $2.00 forever. What is the price
of this stock today if an investor wants to earn

a. 15%?
b. 20%?

ANSWER
There are two dividend patterns here; the first is a constant growth pattern for the next
seven years and then a constant dividend forever. Solve each part separately and then add
the two parts.

Part one: Constant growth for seven years, first find growth rate and note that there are
six changes in the dividend stream over the seven years.

g = ($1.77 / $1.00)1/6 – 1 = 1.771/6 – 1 = 10%

Next, use the finite dividend growth model

Price = Dividend×(1 + g) / (r – g)×[1 – ((1+g) / (1+r))n]

Part two: Use the constant dividend (infinite period) model and then discount the price at
period 7 back to the present

Price7 = Dividend8 / r

Price0 = Price7 / (1 + r)7

a. Part One Price = $1.00 (1.10) / (0.15 – 0.10)×[ 1 – (1.10/1.15)7]

Part One Price = $22.00×0.2674 = $5.88
Part Two Price = ($2.00 / 0.15) / (1.15)7 = $13.33 / 2.66 = $5.01
Price = $5.88 + $5.01 = $10.89
b. Part One Price = $1.00 (1.10) / (0.20 – 0.10)×[ 1 – (1.10/1.20)7]
Part One Price = $11.00×0.4561 = $5.02
Part Two Price = ($2.00 / 0.20) / (1.20)7 = $10.00 / 3.5832 = $2.79
Price = $5.02 + $2.79 = $7.81

10. Staton-Smith Software is a new up-start company and will not pay dividends for the
first five years of operation. It will then institute an annual cash dividend policy of
$2.50 with a constant growth rate of 5% with the first dividend at the end of year six.

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 Chapter 7  Stocks and Stock Valuation 186

The company will be in business for 25 years total. What is the price of this stock if
an investor wants
a. a 10% return?
b. a 15% return?
c. a 20% return?
d. a 40% return?

ANSWER
Calculate the price at the beginning of the sixth year (end of the fifth year) with the finite
constant growth dividend model and then discount the price by five years to the present
value.

a. Price5 = $2.50 / (0.10 – 0.05)×[1 – (1.05/1.10)20]

Price5 = $50.00×0.6056 = $30.28
Price0 = $30.28 / 1.105 = $30.28 / 1.6105 = $18.80
b. Price5 = $2.50 / (0.15 – 0.05)×[1 – (1.05/1.15)20]
Price5 = $25.00×0.8379 = $20.95
Price0 = $20.95 / 1.155 = $20.95 / 2.0114 = $10.41
c. Price5 = $2.50 / (0.20 – 0.05)×[1 – (1.05/1.20)20]
Price5 = $16.67×0.9308 = $15.51
Price0 = $15.51 / 1.205 = $15.51 / 2.4883 = $6.23
d. Price5 = $2.50 / (0.40 – 0.05)×[1 – (1.05/1.40)20]
Price5 = $7.14×0.9968 = $7.12
Price0 = $7.12 / 1.405 = $7.12 / 5.3782 = $1.32

11. Fenway Athletic Club plans to offer its members preferred stock with a par value of
$100 and a 6% annual dividend rate. What price should these members be willing to
pay for the returns they want?
a. Theo wants a 10% return.

b. Jonathan wants a 12% return

c. Josh wants a 15% return

d. Terry wants an 18% return

ANSWER
Use the constant dividend model with infinite horizon

Price = Dividend / r

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a. Theo’s Price = $100×0.06 / 0.10 = $60.00

b. Jonathan’s Price = $100×0.06 / 0.12 = $50.00
c. Josh’s Price = $100×0.06 / 0.15 = $40.00
d. Terry’s Price = $100×0.06 / 0.18 = $33.33

12. Yankee Athletic Club has preferred stock with a par value of $50 and an annual 6%
cumulative dividend. Given the following market prices for the preferred stock, what
is each investor seeking for his or her return?
a. Alex is willing to pay $40.00

b. Derek is willing to pay $30.00

c. Mark is willing to pay $20.00

d. Johnny is willing to pay $15.00

ANSWER
Use the constant dividend formula rearranged for the return, r = Dividend/ Price where
the dividend is $50.00×0.06 = $3.00

a. Alex’s return = $3.00 / $40.00 = 0.075 or 7.5%

b. Derek’s return = $3.00 / $30.00 = 0.10 or 10%
c. Mark’s return = $3.00 / $20.00 = 0.15 or 15%
d. Johnny’s return = $3.00 / $15.00 = 0.20 or 20%

13. VillalpandoWinery wants to raise $10 million from the sale of preferred stock. If the
winery wants to sell 1 million shares of preferred stock, what annual dividend will it
have to promise if investors demand
a. a 12% return?

b. an 18% return?

c. an 8% return?

d. a 6% return?

e. a 9% return?

f. a 7% return?

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ANSWER
Use the constant dividend formula rearranged for the dividend,

Dividend = r×Price

And the price of the shares is $10,000,000 / 1,000,000 = $10.00 per share

a. A 12% return means: Dividend = 12%×$10.00 = $1.20 per year

b. A 18% return means: Dividend = 18%×$10.00 = $1.80 per year
c. A 8% return means: Dividend = 8%×$10.00 = $0.80 per year
d. A 6% return means: Dividend = 6%×$10.00 = $0.60 per year
e. A 9% return means: Dividend = 9%×$10.00 = $0.90 per year
f. A 7% return means: Dividend = 7%×$10.00 = $0.70 per year

14. Find the annual growth rate of the dividends for each of the firms listed in the table
below.

Dividend Payment per Year

Firm 2006 2007 2008 2009 2010 2011

Loewen $1.00 $1.05 $1.10 $1.16 $1.22 $1.28

Morse $1.00 $0.90 $0.81 $0.73 $0.66 $0.59

Huddleston $1.00 $1.00 $1.00 $2.00 $2.00 $2.00

Meyer $0.00 $0.00 $0.25 $0.50 $0.75 $1.00

ANSWER
Either find the change each year and then average the change or
g = (Dividend 2011 / Dividend 2006)1/5 – 1

Loewen g = ($1.28 / $1.00)0.20 – 1 = 0.0506 = 5.06%

Morse g = ($0.59 / $1.00)0.20 – 1 = -0.10 = negative 10%

Huddleston g = ($2.00 / $1.00)0.20 – 1 = 0.1487 = 14.87%

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Meyer g = can only measure for the years 2008 to 2011, ($1.00 / $0.25)1/3 – 1 = 0.5874 =
58.74%

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