Problem Set 3

Problem Set 3 - Department of Economics Lehigh University...

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Department of Economics Professor O’Brien Lehigh University Spring 2009 Eco 29 Problem Set 3 1. Suppose a stock is expected to pay a dividend of $1.20 per share one year from now, when its price is expected to be $44. If the required rate of return on the stock is 13%, what is its price? 2. Suppose you expect Longs Drug Store to pay dividends of $0.56 per share in the coming year and have a price of $45.50 at the end of the year. If investments with equal risk to Longs’ stock have an expected return of 6.80%, what is the most you would pay today for Longs’ stock? What dividend yield and rate of capital gain would you expect at this price? 3. Suppose a company is expected to pay a dividend of $100 per share per year forever. If the required rate of return on the stock is 20%, what is its price? 4. Suppose that a stock is currently paying a dividend of $10 per share on a stock. Investors expect the dividend to grow at a rate of 5% per year. If the required rate of return on the stock is 13.5%, what is its price? 5. Consolidated Edison, Inc. (Con Ed) is a regulated utility company servicing the New York City area. Suppose Con Ed plans to pay a dividend of $2.30 per share at the end of the current year. If its equity cost of capital is 7% and dividends are expected to grow by 2% per year in the future, estimate the value of Con Ed’s stock. 6. During 1999 one stock analyst predicted that Amazon.com would soon be earning $10 per share of stock and that Amazon’s dividends would grow at a rate of 7% per year. If you believed this analyst’s forecasts and your required rate of return on this investment was 10%, what price would you have been willing to pay for Amazon’s stock? What is the closing price of Amazon’s stock today? Relate your answer to the dot.com stock bubble of the late 1990s. 7. Suppose that eLake, an online auction site, is paying a dividend of $2.00 per share. You expect this dividend to grow at a rate of 2% per year, and the required return on this investment is 10%. What is the most you would be willing to pay for a share of eLake stock? Suppose your required return is only 5%.
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Problem Set 3 - Department of Economics Lehigh University...

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