Problem Set 7 Sol.pdf

# Problem Set 7 Sol.pdf - Problem Set 7 Foundations of...

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Problem Set 7 Foundations of Finance Question 1: Use the constant dividend growth model to suggest which of the following three stocks you should invest in. Explain your answer. Firm X Firm Y Firm Z Dividend per Share (d1) \$1 \$10 \$15 Current Share Price \$100 \$180 \$200 R 10% 10% 10% Return on Equity 10% 10% 15% Reinvestment in Firm / Plow back (b) 95% 50% 25% SOL: Firm X Firm Y Firm Z Growth 9.5% 5% 3.75% Value=D/(R-g) 200 200 240 All these shares have estimated values above the market price. Since I did not limit you to choose one of them you would like to invest in all of them. Question 2: Suppose that the consensus forecast of security analysts of XYZ company is that the earnings next year will be E 1 = \$5 per share. Suppose that the company tends to plow back 50% of its earnings and pay the rest as dividends. The Chief Financial Officer (CFO) estimates that the company’s growth rate will be 6% from now onwards. (a) If your estimate of the company’s required rate of return on its stock is 10%, what is the equilibrium price of the stock?
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• Fall '14
• EduardoDavila

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