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428_PS1_sol_S09 - AEM 428 Spring 2009 Professor Manny Dong...

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AEM 428 Spring 2009 Professor Manny Dong Problem Set 1 1) Please provide on a separate sheet an introduction of yourself. Attach a picture to that. List your year, name, major, and a brief description of one or more of the following: career goal, hobby, or reason for taking this class. 2) At the beginning of 1968 General Foods (GF) had just paid a dividend of $2.20 per share, and its stock price was $73.50. Given the dividend history of the company for the past 10 years, use the Gordon formula to estimate the cost of equity: Year-End Dividend 1958 $1.00 1959 $1.15 1960 $1.30 1961 $1.40 1962 $1.60 1963 $1.80 1964 $2.00 1965 $2.00 1966 $2.10 1967 $2.20 Ans: (note: treat the beginning of 1968 the same as the end of 1967, which is our time 0) Recall Gordon Growth Model i.e. P = D/(r-g) Cost of equity according to Gordon Growth Model is: r = D/P + g Average growth rate using the average of growth rate in past 10 years: 9.27% Expected end of 1968 dividend = 2.2*(1+9.27%) =2.40 Share price at the beginning of 1968 = 73.50 D/P = 2.40 / 73.50 = 3.27% Cost of equity = D/P + Dividend Growth = 3.27 + 9.27 = 12.54% 3) The XYZ corp. has just paid a dividend of $4 per share. You believe that this dividend, paid annually, will grow by 20% per year for the next 5 years, and will then grow by 8% annually forever. XYZ currently trades for $63 per share. What is the discount rate implied by this price? (just set this one up. If you have a financial calculator, then solve it, otherwise setting it up is fine). Ans: Price equals to the sum of two parts. First, dividends next five years are discounted to today’s value. Each year dividend grows by 20%. Second, at the end of fifth year, the discounted value of the value at that point.
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