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Unformatted text preview: ECONOMICS 389 – Solution of HW #2 Spring 2010 1. The two firms have equal risk, so we can use the data for Androscoggin to find the expected return on either stock: r = DIV 1 P + g = 5 100 + 0 . 05 = 0 . 1 = 10% 2. a. P = DIV 1 r g = 3 × 1 . 05 . 15 . 05 = 31 . 5 b. P = 3 × 1 . 05 . 12 . 05 = 45 With the lower discount rate the PV of every future dividend is higher. 3. In this case, the growth rate is negative: g = . 1. a. P = DIV 1 r g = 3 [0 . 15 ( . 1)] = 3 . 25 = 12 b. P 1 = DIV 2 r g = 3(1 . 1) . 25 = 10 . 8 c. return = ( DIV 1 + P 1 P ) P = [3 + (10 . 80 12)] 12 = 0 . 15 = r d. “Bad” companies may be declining, but if the stock price already takes this into account, an investor can still earn a fair rate of return. 4. Here ROE = 0 . 2, plowback ratio = 0 . 3, E = $4, r = 0 . 12. a. To find P we need g and DIV 1 g = ROE × plowback ratio = 0 . 2 × . 3 = 0 . 06 DIV 1 = (1 plowback ratio ) × E = 0 . 7 × 4 = 2 . 8 1 P = DIV 1 r g = 2 . 8 . 12 . 06 = 46 . 67 P/E...
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This note was uploaded on 04/13/2010 for the course ECO 389 taught by Professor Chen,j during the Spring '08 term at SUNY Stony Brook.
 Spring '08
 Chen,J
 Economics

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