CHAPTER 8
STOCK VAULATION problems
1- Flex Electronics is forecasted to pay a $5.00 dividend at the end of
year one and a $5.50 dividend at the end of year two. At the end of
the second year the stock will be sold for $121. If the discount rate
is 15%, what is the price of the stock?
P0 = 500/(1+.15) + 5.50+121 /(1+.15)2
=$100
2- Suppose TB Pirates, Inc., is expected to pay a $2 dividend in one
year. If the dividend is expected to grow at 5% per year and the
required return is 20%, what is the price?
P0 = 2 / (.2 - .05) = $13.33
3- What is the value of a stock that is expected to pay a constant
dividend of $2 per year if the required return is 15%?
Zero growth: 2 / .15 = 13.33
4- What if the company starts increasing dividends by 3% per year,
beginning with the next dividend? The required return stays at
15%.
Constant growth: 2(1.03) / (.15 - .03) = $17.17
5- Gordon Growth Company is expected to pay a dividend of $4 next
period, and dividends are expected to grow at 6% per year. The
required return is 16%. What is the current price?
P0 = 4 / (.16 - .06) = $40
Remember that we already have the dividend expected next year,
so we don’t multiply the dividend by 1+g
What is the price expected to be in year 4?
1
P4 = D4(1 + g) / (R – g) = D5 / (R – g)
P4 = 4(1+.06)4 / (.16 - .06) = 50.50
What is the implied return given the change in price during the
four year period?
50.50 = 40(1+return)4; return = 6%
The price is assumed to grow at the same rate as the dividends
6- Suppose a firm is expected to increase dividends by 20% in one
year and by 15% in two years. After that, dividends will increase at
a rate of 5% per year indefinitely. If the last dividend was $1 and
the required return is 20%, what is the price of the stock?
Remember that we have to find the PV of all expected future
dividends.
Compute the dividends until growth levels off
D1 = 1(1.2) = $1.20
D2 = 1.20(1.15) = $1.38
D3 = 1.38(1.05) = $1.449
Find the expected future price
P2 = D3 / (R – g) = 1.449 / (.2 - .05) = 9.66
Find the present value of the expected future cash flows
P0 = 1.20 / (1.2) + (1.38 + 9.66) / (1.2)2 = 8.67
7- XYZ stock currently sells for $50 per share. The next expected
annual dividend is $2, and the growth rate is 6%. What is the
expected rate of return on this stock?
If the required rate of return on this stock were 12%, what would
the stock price be, and what would the dividend yield be?
Expected return = 2/50 + .06 = .10
Price = 2/ (.12 - .06) = $33.33
Dividend yield = 2 / 33.33 = 6%
2
8- You observe a stock price of $18.75. You expect a dividend growth
rate of 5%, and the most recent dividend was $1.50. What is the
required return?
r = [1.5(1.05)/18.75] + .05 = 13.4%
9- Suppose a firm’s stock is selling for $10.50. It just paid a $1
dividend, and dividends are expected to grow at 5% per year.
What is the required return?
• R = [1(1.05)/10.50] + .05 = 15%
-What is the dividend yield?
1(1.05) / 10.50 = 10%
-What is the capital gains yield?
g =5%
10-A company has just paid a dividend of 30 cents per share and that
dividend is expected to grow at a rate of 10 per cent per annum
for the next three years, and at a rate of 3 per cent per annum
forever after that.
Assuming a required rate of return of 14 per cent, calculate the
current market price of the share.
3
D4
P3 =
r − g
$0 . 411
¿
0 . 14− 0 . 03
¿ $3 . 74
D1 D2 D3 P3
P0 = 1
+ 2
+ 3
+
( 1+ r ) ( 1+ r ) ( 1+ r ) ( 1+ r )3
$0 . 330 $0 .363 $0 .399 $3 .74
¿ + 2
+ 3
+
1 .14 ( 1. 14 ) ( 1. 14 ) ( 1. 14 )3
¿ $0 . 289+$0 .279+ $0. 269+$2 .524
¿ $3 . 36
