Assignment No:6

MIS ID:29787
BBA 3A

Business Fianace

Mam mehwish khan

Question 1:
James Consol Company currently pays a dividend of $1.60 per share on its
common stock. The company expects to increase the dividend at a 20 percent
annual rate for the first four years and at a 13 percent rate for the next four
years, and then grow the dividend at a 7 percent rate thereafter. This phased-
growth pattern is in keeping with the expected life cycle of earnings. You require
a 16 percent return to invest in this stock. What value should you place on a
share of this stock?

Answer:
Under dividend discount model, price of the share is equal to the present value of
future dividend and that of the terminal value. Dividend for each year is calculated by
multiplying the previous dividend by (1+gi) where gi is the growth rate for the
respective year.
Terminal value is the dividend for first year of the constant growth phase, divided by
(r-g) where r is the required rate of return and g is the constant growth rate.
Discount rate applied for ascertaining present value is the required rate of return.
Current share price is ascertained at $33.46 as follows:

Question 2:
Just today, Acme Rocket, Inc.’s common stock paid a $1 annual dividend per
share and had a closing price of $20. Assume that the market expects this
company’s annual dividend to grow at a constant 6 percent rate forever.
a. Determine the implied yield on this common stock.
b. What is the expected dividend yield?
c. What is the expected capital gains yield?

Answer:

1. Market price of shares = dividend 1/(required return- growth rate)

20 = 1/(0.06-g)
0.06-g = 1/20
g= 0.06-0.05
g= 0.01 or 1.00%

2. Dividend yield =dividend /stock price

=1/20
=5.00%

3. Growth rate = capital gains yield 1.00%

Question 3:

Stock Values The Starr Co. just paid a dividend of $1.90 per share on its stock.
The dividends are expected to grow at a constant rate of 5 percent per year,
indefinitely. If investors require a 12 percent return on the stock, what is the
current price? What will the price be in three years? In 15 years?

Answer

STEP 1 :
The price of a stock is the present value of all future cash flows from the stock. The
cash flows from the stock are dividends. The rate is used to discount the future cash
flow is the required rate of return from the stock. If a stock's dividend grows at a
certain percentage for indefinite period then the stock will be called as constant
growth stock.
The formula to compute the price of stock with constant growth is provided below.

Pt = [Dr × (1+g)]/[r - g]
Where
The dividend at timet is Dt.
The required rate of return is r
The price of share at time is Pt.
The constant growth rate is g.

STEP 2 :
Here, the current dividend is $1.90, the
constant growth rate is 5% and the required
return is 12%.
Compute the current price of stock as
follows:
Po =[ Do × (1+g)]/[r-g]
=[ $1.90 × (1+5%)]/[12%-5%]
= 1.996% / 7%
= 28.50
Thus the current price of the stock is $28.50

STEP 3:
Compute the price of stock in Year - 3 as follows.
P3= [Do × (1+g)^4] / [r-g]
P3= [ $1.90 × (1+5%)^4] / [12% - 5%]
P3= [2.309461875 / 7%]
P3= 32.9923
Thus the price of the stock in Year 3 will be $32.99

STEP 4:
Compute the price of stock in Year 15 as follows.
P15= [Do × (1+g)^16] / [12% - 5%]
P15= [4.14746171 / 7%]
P15= 59.2494
Thus the price of the stock in Year 15 will be $59.25

Question 4
Stock Values The next dividend payment by ECY, Inc., will be $2.85 per share. The
dividends are anticipated to maintain a 6 percent growth rate, forever. If ECY stock
currently sells for $58 per share, what is the required return?

.
Answer:

STEP 1:
Given Information is summarized below:
Next dividend payment is Div = $2.85 per
Share growth rate is g = 6% ie 0.06
Current Stock price ie Po = $58
STEP 2:
Calculation of required rate of return:
All variable are as pergiven information.
R= [Div / Po] +g
Where,
R= required rate of return
Div= dividend per share at the end of 1 year
Po= Current stock price
g = growth rate
On substituting the variables on the above formula:
R= [Div / Po] +g
R= [$2.85 / $58] + 0.06
R= 0.04914 + 0.06
R= 0.10914
R= 10.914%
Required rate of return ie R = 10.914%

Question5

Stock Values For the company in the previous problem, what is the dividend yield?
What is the expected capital gains yield?

Answer:

STEP 1:
The expected dividend for the next year is $2.85 and dividend growth rate is 6% the
current price of the stock is $58 Now the required return can be valued as per
dividend growth model According to this approach the required return can be valued
as :
Po= [Do × (1+g)] / [ r - g ]
r= [D1 / Po] +g
Where Po is the current stock price D1 is the next dividend g is the constant growth
rate and r is the required return of the investors the two components are D1/Po and g
the first commponent of the equation represents the dividend yield and second
components is capital gain yield.

STEP 2:
The dividend yield tell the return of the investors if the dividend and stock prices
remain constant it can be calculated by dividing dividend with recent stock prices the
dividend yield of the company is as follows ;
Dividend yield = [ dividend/ stock price ] × 100
Dividend yield= [$2.85 / $58 ] × 100
Dividend yield= 4.914%
Therefore the current dividend yield of the stock is 4.914% and as discussed above g
ie 6% is the capital gain yield.

Question 6
Stock Values White Wedding Corporation will pay a $3.05 per share dividend next
year. The company pledges to increase its dividend by 5.25 percent per year,
indefinitely. If you require an 11 percent return on your investment, how much will
you pay for the company’s stock today?

Answer:

STEP 1:
Stock value Po: The current value of the stock Po should be equal to all of its future
cash flows ie dividend are discounted at some required rate.
Therefore the current value of stock is the present value of its annual expected
dividends payments. The following is the formula to calculate the current price stock
value.

Stock price Po = [ Do(1+g)]/ [R-g]

Stock price Po=. [D1/(R-g)]
Here
Do is the recent dividend paid
D1 is the expected dividend to pay
g is the dividend growth rate
R is the required return on stock

STEP 2:
Detailed Information:
Expected dividend will pay in next year D1 is $3.05 per year.
Expected increase the dividend growth rate g is 5.25 % per year indefinitely
Required return on investment R is 11%
Calculate the current stock price Po:
Stock price Po=. [D1/(R-g)]
Stock price Po=[ 3.05$ / (0.11 - 0.0525)]
Stock price Po= [ $3.05 / 0.0575]
Stock price Po= $53.04
Therefore the current stock price is Po $53.04.

Question 7 .

Stock Valuation Siblings, Inc., is expected to maintain a constant 5.8 percent growth
rate in its dividends, indefinitely. If the company has a dividend yield of 4.7 percent,
what is the required return on the company’s stock?

Answer:

STEP 1:
Given Information is summarized below:
Constant growth rate is g = 5.8%
Dividend yield = 4.7%
Note:
As per the given information Div/Po ie Dividend yield= 4.7% and g = 5.8%
STEP 2:
Calculation of required rate of return:
All variable are as per given Information
R= [Div/Po]+g
Where
R= required rate of return
Div/ Po = Dividend yield
g = growth rate
On substituting the variables in the formula:
R= [Div/Po]+g
R= 4.7% + 5.8%
R= 10.5%
Required rate of return ie R = 10.5 %

Question 8

Valuing Preferred Stock Ayden, Inc., has an issue of preferred stock outstanding
that pays a $6.40 dividend every year, in perpetuity. If this issue currently sells for
$103 per share, what is the required return?

Answer:

STEP 1:
Preferred Stock:
Preferred stock investment is the one of the sourcessof
long-term financing by the firm. The investment in preferred stock will not
provide any voting rights to the preferred shareholders. Preferred shareholders are
seems like the debt holders of the firm. At the time of liquidation of the firm the
preferred shareholders will give a priority to clear the payments first than the common
stock holders.

STEP 2:
Detailed Information;
Preferred annual dividend per share D is $6.40.
Preferred stock current selling price per share P is $103
Formula to calculate the value of the preferred stock:
Preferred stock value P = [ preferred dividend D / Required return on preferred stock
R]

STEP 3:
Calculate the value of the preferred stock:
Preferred stock value P = [ preferred dividend D / Required return on preferred stock
R]
$103 = $6.40/ R
Required return on preferred stock R = $6.40 / $103
Required return on preferred stock R = 0.062135922 or 6.21%
Therefore the required return on preferred stock R is 6.21%.

Question 9

Non-constant Dividends North Side Corporation is expected to pay the following

dividends over the next four years: $9, $7, $5, and $2.50. Afterwards, the company
pledges to maintain a constant 5 percent growth rate in dividends forever. If the
required return on the stock is 13 percent, what is the current share price?

Answer:

STEP 1:
Given information is summarized below:
Dividends over next four Years:
Dividend after 1"Year ie. Div= $9
2nd Year dividend ie. D2 =$7
3n Year dividend ie. D3 = $5
4th Year dividend i.e. D4 = $2.50

After 4th Year dividend = 5% ie. 0.05

constant growth i.e. g

Required Return on = 13%

Stock i.e. R
In this problem, it is very straight to calculate the 4th Year Stock Price i.e. P4
Later this should be discounted along with the previous year's dividends to find out
the
Current Stock Price i.e. Po.

STEP 2:
Calculating of 4th year price P4 :
All variables are as per given information.
P4= D5/(R-g)
D5= D4 (1+g)
Where
Where,
P4, =4h Year Stock Pr ice
D5 =5h Year dividend per Share
D4 =4th Year dividend per Share
R =Required Re turm
g =Growth Rate

D5 = $2.50(1+0.05)
D5 = $2.50 (1.05)
D5 = $2.625

P4= $2.625/(13%-5%)
P4= $2.625 / 8%
P4= $32.81

STEP 3:
Calculation of Current Year Stock Price ie.
Po:
P4 is as per Given information = $32.8 and all other variables are as per Given
information.
Po= Div/(1+R)+ D2/ (1+R)^2 + D3/ (1+R)^3 + D4/ (1+R)^4 + P4 /(1+R)^4
Where,
Po= Present value of the Stock Price
Div= Dividend per Share at the end of l"year
R =Required Rate of Return
D2 =2nd Year Dividend
D3 =3 Year Dividend
D4, =4th Year Dividend
P4 =4h Year Stock Price

On substituting the variables in the formula:

Po= Div/(1+R)+ D2/ (1+R)^2 + D3/ (1+R)^3 + D4/ (1+R)^4 + P4 /(1+R)^4

Po= [ $9/(1+0.13) + $7/(1+0.13)^2 + $5/(1+0.13)^3 + $2.50/ (1+0.13)^4
+32.81(1+0.13)^4 ]
Po= $7.96+$5.48+$3.47+$1.53+$20.12
Po=$38.56
The Current Stock Price i.e. Po =$38.56