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ACSTC 371
Assignment #2 – Solutions
Question 1:
a.
Price = 104.60
b.
YTM = 7.28%
Question 2
:
6.15
a.
P = $2 / (0.12  0.05) = $28.57
b.
P
10
= D
11
/ (r  g)
= $2 (1.05
10
) / (0.12  0.05)
= $46.54
6.24
Express the rate of return in terms of the dividend yield and
g
, the growth rate of
dividends.
The dividend yield is the next dividend payment,
Div
1
, divided by the current
stock price,
P
.
The rate of return,
r
, is equal to the sum of the dividend yield and
g
.
r
= Div
1
/ P + g
To solve for the growth rate,
g
, apply the formula for the growth rate of a firm’s earnings.
g
= Retention Ratio
×
Return on Retained Earnings
= (0.75) (0.12)
= 0.09
Find the dividend payment per share made yesterday.
Since the retention ratio is 75
percent, the firm pays out 25 percent of its $10 million earnings as dividend payments.
Thus, the total dividend payment made yesterday was $2,500,000 [=$10,000,000
×
(1 –
0.75)].
To find the dividend paid per share, divide the total dividend payment by the total
number of shares outstanding.
Dividend per Share
= [Total Earnings
×
(1 – Retention Ratio)] / Number of
Shares
= [$10,000,000
×
(1 – 0.75)] / 1,250,000
=
$
2
Take note that the dividend payment
next
year is needed to solve for the rate of return,
r
.
Next year, the firm’s earnings and dividend will grow at the annual growth rate of nine
percent, as calculated above.
Thus, the dividend will be $2.18 (=$2
×
1.09).
Solve for
the discount rate,
r
.
r
= Div
1
/ P
0
+ g
= $2.18 / $30 + 0.09
= 0.1627
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View Full Document The rate of return on the stock is 16.27 percent.
6.27
a.
Value the firm as a “cash cow,” ignoring future projects.
Apply the perpetuity
formula to calculate the PV of the firm’s revenues.
The price per share is the PV
of the revenues divided by the number of shares outstanding.
PV
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This note was uploaded on 04/27/2010 for the course ACTSC 371 taught by Professor Wood during the Spring '08 term at Waterloo.
 Spring '08
 Wood

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