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Answers to Concepts Review and Critical Thinking Questions
4.
The general method for valuing a share of stock is to find the present value of all expected future
dividends. The dividend growth model presented in the text is only valid (i) if dividends are expected
to occur forever, that is, the stock provides dividends in perpetuity, and (ii) if a constant growth rate
of dividends occurs forever. A violation of the first assumption might be a company that is expected
to cease operations and dissolve itself some finite number of years from now. The stock of such a
company would be valued by applying the general method of valuation explained in this chapter. A
violation of the second assumption might be a startup firm that isn’t currently paying any dividends,
but is expected to eventually start making dividend payments some number of years from now. This
stock would also be valued by the general dividend valuation method explained in this chapter.
6.
The two components are the dividend yield and the capital gains yield. For most companies,
the capital gains yield is larger. This is easy to see for companies that pay no dividends. For
companies that do pay dividends, the dividend yields are rarely over five percent and are
often much less.
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.
Solutions to Questions and Problems
Basic
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
) = EGP 8.40 (1.06) / (.12 – .06) = EGP 148.40
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
) = EGP 8.40 (1.06)
4
/ (.12 – .06) = EGP 176.75
We can do the same thing to find the dividend in Year 16, which gives us the price in Year 15, so:
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 Spring '10
 JinWanChoi

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