C7 P12 17 20 21 22 23 24 Solution

# C7 P12 17 20 21 22 23 24 Solution - Chapter 7, Problem 12...

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Chapter 7, Problem 12 Here, we need to value a stock with two different required returns. Using the constant growth model and a required return of 15 percent, the stock price today is: P 0 = D 1 / (R – g) P 0 = \$2.60 / (0.15 – 0.045) P 0 = \$24.76 The stock price today with a 10 percent return will be: P 0 = D 1 / (R – g) P 0 = \$2.60 / (0.10 – .045) P 0 = \$47.27 All else held constant, a higher required return means that the stock will sell for a lower price. Also, notice that the stock price is very sensitive to the required return. In this case, the required return fell by one-third but the stock price doubled. Chapter 7, Problem 17 The constant growth model can be applied even if the dividends are declining by a constant percentage, just make sure to recognize the negative growth. So, the price of the stock today will be: P 0 = D 0 (1 + g) / (R – g) P 0 = \$10.50 * (1 – .045) / [(.10 – (–.045)] = \$10.03 / 0.145 P 0 = \$69.16 Chapter 7, Problem 20 Here are two solutions to the problem, Frst comes textbook solution manual and next how we did it in class. Look at them both and pick the one you Fnd easier to follow. Textbook: With supernormal dividends, we Fnd the price of the stock when the dividends level off at a constant growth rate, and then Fnd the present value of the future stock price, plus the present value of all dividends during the supernormal growth period. The stock begins constant growth in Year 6, so we can Fnd the price of the stock in Year 5, one year before the constant dividend growth begins as: P 5 = D 6 / ( R g ) = D 5 (1 + g ) / ( R g ) P 5 = D 0 (1 + g 1 ) 5 (1 + g 2 ) / ( R g ) P 5 = \$2.00(1.195) 5 (1.05) / (.11 – .05) P 5 = \$85.29 The price of the stock today is the present value of the Frst Fve dividends, plus the present value of the Year 5 stock price. The price of the stock today will be: P 0 = \$2.00(1.195) / 1.11 + \$2.00(1.195) 2 / 1.11 2 + \$2.00(1.195) 3 / 1.11 3 + \$2.00(1.195) 4 / 1 . 1 1 4 + \$2.00(1.195) 5 / 1.11 5 + \$85.29 / 1.11 5

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P 0 = \$2.15 + \$2.32 + \$2.50 + \$2.69 + \$2.89 + \$50.62
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## This note was uploaded on 04/05/2011 for the course FIN 350 taught by Professor Debruinne during the Winter '11 term at Grand Valley State University.

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C7 P12 17 20 21 22 23 24 Solution - Chapter 7, Problem 12...

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