Chapter5solutions

# Chapter5solutions - Chapter 5 Basic Stock Valuation ANSWERS...

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Chapter 5 Basic Stock Valuation ANSWERS TO END-OF-CHAPTER QUESTIONS 5-2 True. The value of a share of stock is the PV of its expected future dividends. If the two investors expect the same future dividend stream, and they agree on the stock’s riskiness, then they should reach similar conclusions as to the stock’s value. 5-3 A perpetual bond is similar to a no-growth stock and to a share of preferred stock in the following ways: 1. All three derive their values from a series of cash inflows--coupon payments from the perpetual bond, and dividends from both types of stock. 2. All three are assumed to have indefinite lives with no maturity value (M) for the perpetual bond and no capital gains yield for the stocks. SOLUTIONS TO END-OF-CHAPTER PROBLEMS 5-1 D 0 = \$1.50; g 1-3 = 5%; g n = 10%; D 1 through D 5 = ? D 1 = D 0 (1 + g 1 ) = \$1.50(1.05) = \$1.5750. D 2 = D 0 (1 + g 1 )(1 + g 2 ) = \$1.50(1.05) 2 = \$1.6538. D 3 = D 0 (1 + g 1 )(1 + g 2 )(1 + g 3 ) = \$1.50(1.05) 3 = \$1.7364. D 4 = D 0 (1 + g 1 )(1 + g 2 )(1 + g 3 )(1 + g n ) = \$1.50(1.05) 3 (1.10) = \$1.9101. D 5 = D 0 (1 + g 1 )(1 + g 2 )(1 + g 3 )(1 + g n ) 2 = \$1.50(1.05) 3 (1.10) 2 = \$2.1011. 5-2 D 1 = \$1.50; g = 7%; r s = 15%; 0 P ˆ = ? 0 P ˆ = g r D s 1 = 07 . 0 15 . 0 50 . 1 \$ = \$18.75. 5-3 P 0 = \$20; D 0 = \$1.00; g = 10%; 1 P ˆ = ?; r s = ? 1 P ˆ = P 0 (1 + g) = \$20(1.10) = \$22. r s = 0 1 P D + g = 20 \$ ) 10 . 1 ( 00 . 1 \$ + 0.10

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= 20 \$ 10 . 1 \$ + 0.10 = 15.50%. r s = 15.50%. 5-4 D ps = \$5.00; V ps = \$50; r ps = ? r ps = ps ps v D = 00 . 50 \$ 00 . 5 \$ = 10%. 5-5 0 1 2 3 | | | | D 0 = 2.00 D 1 D 2 D 3 2 P ˆ Step 1: Calculate the required rate of return on the stock: r s = r RF + (r M - r RF )b = 7.5% + (4%)1.2 = 12.3%. Step 2: Calculate the expected dividends: D 0 = \$2.00 D 1 = \$2.00(1.20) = \$2.40 D 2 = \$2.00(1.20) 2 = \$2.88 D 3 = \$2.88(1.07) = \$3.08 Step 3: Calculate the PV of the expected dividends: P V
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## This note was uploaded on 12/11/2011 for the course FINC 3630 taught by Professor Jensen,m during the Summer '08 term at Auburn University.

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Chapter5solutions - Chapter 5 Basic Stock Valuation ANSWERS...

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