PS3AK - Econ 233 Problem Set Answer key Problem Set 3 1 BKM...

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1 Econ 233 Problem Set Answer key Problem Set 3 1. BKM 18: 14 (25 in 7 th edition) Year 0 1 2 3 4 D t (end of year) $1.0000 $1.2500 $1.5625 $1.953125 $2.05078 g (during year) 25.0% 25.0% 25.0% 5.0% a. The dividend to be paid at the end of year 3 is the first installment of a dividend stream that will increase indefinitely at the constant growth rate of 5%. Therefore, we can use the constant growth model as of the end of year 3. The expected price 3 years from now is: P 3 = D 4 /(k – g) = $2.05078/(0.20 – 0.05) = $13.67 The PV of this expected price is: $13.67/1.20 3 = $7.91 The PV of expected dividends in years 1 to 3 : 1.25/1.20 + 1.5625/1.20 2 + 1.9531/1.20 3 = $3.26 Thus the current price should be: P 0 = $7.91 + $3.26 = $11.17 b. Expected dividend yield = D 1 /P 0 = $1.25/$11.17 = 0.112 = 11.2% c. The expected price one year from now is the PV at that time of all future cash flows, i.e., P 2 and D 2 : P 1 = (D 2 + P 2 )/1.20 = ($1.5625 + $13.02)/1.20 = $12.15 The implied capital gain is: (P
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PS3AK - Econ 233 Problem Set Answer key Problem Set 3 1 BKM...

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