Week 4 Homework

P7-2

Chapter 7

Constant Growth Valuation

7–2)

Dividend Expected

Growth Rate

Required ROR stock (rs)

1.50/(.07-.15)=

Stock price

Price = Dividend / (Required Return - Growth Rate)

P7-4

$1.50

7%

15%

Constant Growth Valuation

Boehm Incorporated is expected to pay a $1.50 per share dividend at the end of this year (i.e., D1 = $1.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs, is 15%.

What is the value per share of Boehm’s stock?

$18.75

Preferred Stock Valuation

(7–4)

Dividend

Price of Stock

Required Return

P7-5

$5.00

Zero Growth Stock Price = Dividend / Required Return

$50

Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return?

10% Required Return = Dividend / Price

(7–5)

Nonconstant Growth Valuation

Nonconstant Growth Valuation

Step 1: Calculate the required rate of return using CAPM

A company currently pays a dividend of $2 per share (D0 =

$2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price?

Required Rate of Return = rs = Risk Free Rate + (Market Risk Premium)*Beta beta 1.2

Risk-free rate

7.50%

Market Risk Premium

4.00%

Required ROR

Preferred Stock Valuation

12.3%

Step 2: Calculalte the expected dividends by using the future value function and growth rate

D0

2.00

D1

2.40 D0*(1+Growth Rate)

20% Growth

D2

2.88 D1*(1+Growth Rate)

20% Growth

D3

3.08 D2*(1+Growth Rate)

7% Growth

Step 3: Calculate the horizon value of D3

3.08/0.12-0.07=61.6

Horizon Value = D3 / (required