290 CHAPTER 10 COMMON STOCK VALUATION

entire stream of future dividends from Year 1 to infinity, and discount the entire stream back
to time period zero. After the third year a constant growth model can be used which accounts
for all dividends from the beginning of Year 4 to infinity.
We first calculate the dividends for each individual year of the abnormal growth period,
and we discount each of these dividends at the required rate of return.
D1 ¼ $2:00ð1 þ 0:20Þ ¼ $2:40
D2 ¼ $2:00ð1 þ 0:20Þ2 ¼ $2:88
D3 ¼ $2:00ð1 þ 0:20Þ3 ¼ $3:46
$2:40ð0:820Þ ¼ present value of D1 ¼ $1:97
$2:88ð0:672Þ ¼ present value of D2 ¼ $1:94
$3:46ð0:551Þ ¼ present value of D3 ¼ $1:91
Present value of the first 3 years of dividends 5 $5.82

$3:46ð1:07Þ
P3 ¼ ¼ $24:68,
0:22  0:07

which is the present value of the stock at the end of Year 3 (the beginning of year 4)

P0 ¼ $24:68ð0:551Þ ¼ $13:60,

which is the present value of P3 at time period zero

V0 ¼ $5:82 þ $13:60 ¼ $19:42,

which is the present value of the stock at time period zero—the intrinsic value.
Note that the price derived from the constant model is the price of the stock at the end
of Year 3, which is equivalent to the price of the stock at the beginning of Year 4. Therefore, we
discount it back three periods to time period zero. Adding this value to the present value of all
dividends to be received during the abnormal growth period produces the intrinsic value of
this multiple-growth period stock.

Problems

10-1 Assume that Ritchey Industries is expected by investors to have a dividend growth rate over
the foreseeable future of 8 percent a year, and that the required rate of return for this stock is
13 percent. The current dividend being paid is $2.25. What is the estimated value of the
stock?
10-2 Jay Technology is currently selling for $45 a share with an expected dividend in the coming
year of $2 per share. If the growth rate in dividends expected by investors is 9 percent, what is
the required rate of return for Jay?
10-3 Dukes Longhorn Steaks is currently selling for $50 per share and pays $3 in dividends.
Investors require 15 percent return on this stock. What is the expected growth rate of
dividends?
10-4 Zhou Technology pays $1.50 a year in dividends, which is expected to remain unchanged.
Investors require a 15 percent rate of return on this stock. What is the estimated price?

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10-5 a. Given a preferred stock with an annual dividend of $3 per share and a price of $40, what is
the required rate of return?
b. Assume now that interest rates rise, leading investors to demand a required rate of return
of 9 percent. What will the new price of this preferred stock be?
10-6 An investor purchases the common stock of a well-known company, Toma Inc., for $25 per
share. The expected dividend for the next year is $3 per share, and the investor is confident
that the stock can be sold 1 year from now for $30. What is the implied rate of return?
10-7 a. The current risk-free rate (RF) is 10 percent, and the expected return on the market for the
coming year is 15 percent. Calculate the required rate of return for (1) stock A, with a beta
of 1.0, (2) stock B, with a beta of 1.7, and (3) stock C, with a beta of 0.8.
b. How would your answers change if RF in part (a) were to increase to 12 percent, with the
other variables unchanged?
c. How would your answers change if the expected return on the market changed to 17
percent, with the other variables unchanged?
10-8 The John G. Getsinger Fishing Tours Company is currently selling for $60 and is paying a $3
dividend.
a. If investors expect dividends to double in 12 years, what is the required rate of return for
this stock?
b. John G. Getsinger, CEO, expects dividends to approximately triple in six years. In this
event, what would the required rate of return be?
10-9 Kendall Consulting Company is currently selling for $36, paying $1.80 in dividends, and
investors expect dividends to grow at a constant rate of 8 percent a year.
a. If an investor requires a rate of return of 14 percent for a stock with the riskiness of Kendall
Company, is it a good buy for this investor?
b. What is the maximum an investor with a 14 percent required return should pay for
Kendall Company? What is the maximum if the required return is 15 percent?
10-10 The Parker Dental Supply Company sells at $32 per share, and Ray Parker, the CEO of this
well-known Research Triangle firm, estimates the latest 12-month earnings are $4 per share
with a dividend payout of 50 percent. Dr. Parker’s earnings estimates are very accurate.
a. What is Parker’s current P/E ratio?
b. If an investor expects earnings to grow by 10 percent a year, what is the projected price for
next year if the P/E ratio remains unchanged?
c. Dr. Parker analyzes the data and estimates that the payout ratio will remain the same.
Assume the expected growth rate of dividends is 10 percent, and an investor has a required
rate of return of 16 percent, would this stock be a good buy? Why or why not?
d. If interest rates are expected to decline, what is the likely effect on Parker’s P/E ratio?
10-11 The required rate of return for Ola Industries is 15.75 percent. The stock pays a current
dividend of $1.30, and the expected growth rate is 11 percent. Calculate the estimated price.
10-12 In Problem 1011, assume that the growth rate is 16 percent. Calculate the estimated price
for this stock.
10-13 Hernandez Products is a rapidly growing firm. Dividends are expected to grow at the rate of
18 percent annually for the next 10 years. The growth rate after the first 10 years is expected to
be 7 percent annually. The current dividend is $1.82. Investors require a rate of return of 19
percent on this stock. Calculate the intrinsic value of this stock.

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10-14 Wansley Corporation is currently paying a dividend of $1.60 per year, and this dividend is
expected to grow at a constant rate of 8 percent a year. Investors require a 16 percent rate of
return on Wansley. What is its estimated price?
10-15 Johnson and Johnson Pharmaceuticals is expected to earn $2 per share next year. Johnson has
a payout ratio of 40 percent. Earnings and dividends have been growing at a constant rate of
10 percent per year, but analysts are estimating that the growth rate will be 7 percent a year for
the indefinite future. Investors require a 15 percent rate of return on Johnson and Johnson.
What is its estimated price?
10-16 Puckett Foundries is expected to pay a dividend of $0.60 next year, $1.10 the following year,
and $1.25 each year thereafter. The required rate of return on this stock is 18 percent. How
much should investors be willing to pay for this stock?
10-17 McCalla Food Distributors is currently paying a dividend of $1.80. This dividend is expected
to grow at a rate of 6 percent in the future. McCalla is 10 percent less risky than the market as
a whole. The market risk premium is 7 percent, and the risk-free rate is 5 percent. What is the
estimated price of this stock?
10-18 Mansur Industries is currently paying a dividend of $1 per share, which is not expected to
change in the future. The current price of this stock is $12. What is the expected rate of return
on this stock?
10-19 You expect a stock to increase by a compound factor of 1.7835 over eight years (compound
growth). The current price is $45. The expected dividend is $2.00. The expected return on
this stock is?
10-20 McMillan Company is not expected to pay a dividend until five years have elapsed. At the
beginning of Year 6, investors expect the dividend to be $3 per share and to remain that
amount forever. If an investor has a 25 percent required rate of return for this stock, what
should he or she be willing to pay for McMillan?
10-21 Majadillas is currently selling for $50. It is expected to pay a dividend of $2 next period. If the
required rate of return is 10 percent, what is the expected growth rate?
10-22 Batler Corp is currently selling for $50 and currently paying a $2 dividend. Dividends are
expected to double in eight years. What is the expected rate of return for this stock?
10-23 Wislow Corp. is currently selling for $24, currently paying $2 in dividends, and investors
expect dividends to grow at a constant rate of 6% a year. If an investor has a 15 percent
required rate of return, is the stock a good buy for that investor?
10-24 Naidu Corporation makes advanced computer components. It pays no dividends currently,
but it expects to begin paying $1 a share four years from now. The expected dividends in
subsequent years are also $1 a share. The required rate of return is 14 percent. What is the
estimated price for Naidu?

Computational Problems

10-1 Boni Software Products is currently paying a dividend of $1.20. This dividend is expected to
grow at the rate of 30 percent a year for the next five years, followed by a growth rate of 20
percent a year for the following five years. After 10 years the dividend is expected to grow at the

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