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Quiz - Oct 2006 - Solutions

# Quiz - Oct 2006 - Solutions - Finance 100 Corporate Finance...

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Finance 100: Corporate Finance Professor Michael R. Roberts Quiz 2 October 11, 2006 Name: Solutions Section: Question Maximum Student Score 1 30 2 30 3 40 Total 100 Instructions: Please read each question carefully Formula sheets are attached to the back of the quiz You must show all work to receive credit & all numbers must be precise to the second decimal place. Good luck 1

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1. (45 points) Campbell Soup Co. had \$4 earning per share in the fiscal year ending December 31 1998 and paid 50% of earnings as dividends. Assume that an investor’s required rate of return on equity is 10%. For simplicity, assume that dividends are paid once a year and that the next dividend payment is exactly one year away on December 31, 1999. (a) (10 points) Value the stock as of midnight December 31, 1998 (after receiv- ing the 1998 dividend) assuming annual compounding and that earnings and dividends remain constant into the future. future. Solution: We are given the following information: Earnings per share, E 0 is \$ 4 The payout ratio, d t , is 50%. The required rate of return on Campbell’s equity is 10%. Constant dividends implies g = 0 in the constant dividend growth formula so that the value of the stock is P 0 = \$4 × 0 . 50 0 . 10 = \$20 . (b) (15 points) Now, value the stock as of December 31, 1999 assuming that the 1999 dividend has already been paid and that this year’s earnings are going to be \$4.10 per share. Also assume that earnings grow by 5% per annum and the percentage of earnings paid out as dividends remains constant. Assume that this year’s earnings will be realized exactly one year from today on December 31, 2000. Solution: Assuming the earnings for 1999 will be \$ 4.10 per share and that earnings will experience a 5% per annum growth rate thereafter, The value of the stock is P 0 = 0 . 50 × \$4 . 10 0 . 10 - 0 . 05 = \$41 .
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Quiz - Oct 2006 - Solutions - Finance 100 Corporate Finance...

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