Chapter8solutions

Chapter8solutions - CHAPTER 8 STOCK VALUATION Answers to...

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CHAPTER 8 STOCK VALUATION Answers to Concepts Review and Critical Thinking Questions 5. The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred. However, the preferred is less risky because of the dividend and liquidation preference, so it is possible the preferred could be worth more, depending on the circumstances. 7. Yes. If the dividend grows at a steady rate, so does the stock price. In other words, the dividend growth rate and the capital gains yield are the same. 11. Presumably, the current stock value reflects the risk, timing and magnitude of all future cash flows, both short-term and long-term. If this is correct, then the statement is false. Solutions to Questions and Problems 1. The constant dividend growth model is: P t = D t × (1 + g ) / ( R g ) So the price of the stock today is: P 0 = D 0 (1 + g ) / ( R g ) = $1.95 (1.06) / (.11 – .06) = $41.34 The dividend at year 4 is the dividend today times the FVIF for the growth rate in dividends and four years, so: P 3 = D 3 (1 + g ) / ( R g ) = D 0 (1 + g) 4 / ( R g ) = $1.95 (1.06) 4 / (.11 – .06) = $49.24 We can do the same thing to find the dividend in Year 16, which gives us the price in Year 15, so: P 15 = D 15 (1 + g ) / ( R g ) = D 0 (1 + g) 16 / ( R g ) = $1.95 (1.06) 16 / (.11 – .06) = $99.07 There is another feature of the constant dividend growth model: The stock price grows at the dividend growth rate. So, if we know the stock price today, we can find the future value for any time in the future we want to calculate the stock price. In this problem, we want to know the stock price in three years, and we have already calculated the stock price today. The stock price in three years will be: P 3 = P 0 (1 + g ) 3 = $41.34(1 + .06) 3 = $49.24 And the stock price in 15 years will be: P 15 = P 0 (1 + g ) 15 = $41.34(1 + .06) 15 = $99.07
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2. We need to find the required return of the stock. Using the constant growth model, we can solve the equation for R . Doing so, we find: R = (D 1 / P 0 ) + g = ($2.10 / $48.00) + .05 = .0938 or 9.38% 3. The dividend yield is the dividend next year divided by the current price, so the dividend yield is: Dividend yield = D 1 / P 0 = $2.10 / $48.00 = .0438 or 4.38% The capital gains yield, or percentage increase in the stock price, is the same as the dividend growth rate, so: Capital gains yield = 5% 5. The required return of a stock is made up of two parts: The dividend yield and the capital gains yield. So, the required return of this stock is:
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This note was uploaded on 07/01/2010 for the course ECON 393 taught by Professor D during the Summer '10 term at Rutgers.

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Chapter8solutions - CHAPTER 8 STOCK VALUATION Answers to...

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