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Tut06q - July 2009 Strictly for course AB102(2009 internal...

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July 2009 Strictly for course AB102 (2009) internal circulation only. Nanyang Business School AB102 Financial Management Tutorial 6: Stocks and Their Valuation (Common Questions) 1) (9-19) Constant growth . Your broker offers to sell you some shares of Bahnsen & Co. common stock that paid a dividend of $2 yesterday . Bahnsen’s dividend is expected to grow at 5 percent per year for the next 3 years, and, if you buy the stock, you plan to hold it for 3 years and then sell it. The appropriate discount rate is 12 percent. a) Find the expected dividend for each of the next 3 years; that is, calculate D 1 , D 2 , and D 3 . Note that D 0 = $2.00. b) Given that the first dividend payment will occur 1 year from now, find the present value of the dividend stream; that is, calculate the PV of D 1 , D 2 , and D 3 , and then sum these PVs. c) You expect the price of the stock 3 years from now to be $34.73; that is, you expect 3 P e to equal $34.73. Discounted at a 12 percent rate, what is the present value of this expected future stock price? In other words, calculate the PV of $34.73. d) If you plan to buy the stock, hold it for 3 years, and then sell it for $34.73, what is the most you should pay for it today? e) Use Equation 9-2 g r D P s - = 1 0 u to calculate the present value of this stock. Assume that g = 5%, and it is constant. f) Is the value of this stock dependent upon how long you plan to hold it? In other words, if your planned holding period were 2 years or 5 years rather than 3 years, would this affect the value of the stock today, 0 P e ? Explain.
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