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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The rate of return on the stock is 16.27 percent.
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 Spring '08
 Wood
 Time Value Of Money, Net Present Value, Dividend, Dividend yield

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