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ARE143_CHAP_6a_KEY

# ARE143_CHAP_6a_KEY - 1 Managerial Economics(ARE 143...

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1 Managerial Economics (ARE) 143 University of California, Davis Instructor: John H. Constantine KEY—Chapter 6—Common Stock Valuation Problem 1: World-Tour Co. has just now paid a dividend of \$2.83 per share; the dividends are expected to grow at a constant rate of 6% per year forever. If the required rate of return on the stock is 16%, what is the current value on stock, after paying the dividend? P 0 = (2.83*1.06)/(0.16 - 0.06) = \$30 Problem 2: MJ Co. pays out 60% of its earnings as dividends. Its return on equity is 15%. What is the stable dividend growth rate for the firm? g = (1 - 0.60)*15 = 6% Problem 3: The In-Tech Co. has just paid a dividend of \$1 per share. The dividends are expected to grow at 25% per year for the next three years and at the rate of 5% per year thereafter. If the required rate of return on the stock is 18%, what is the current value of the stock? 0 2 3 3 2.0508 (0.18 0.05) 1.25 1.5625 1.9531 P \$12.97 1.18 1.18 1.18 1.18 Problem 4: Ocean Co. has paid a dividend \$2 per share out of earnings of \$4 per share. If the book value per share is \$25, what is the expected growth rate in dividends (g)? Payout ratio = 50%; Plowback ratio = 50%; g = (1 - 0.5) (4/25) = 0.08 or 8% Problem 5: Universal Air is a no growth firm and has two million shares outstanding. It is expected to earn a constant 20 million per year on its assets. If all earnings are paid out as dividends and the cost of capital is 10%, calculate the current price per share for the stock. EPS = DPS = 20/2 = \$10 per share; P 0 = 10/0.1 = 100 Problem 6: (a) BBB, Inc. expects earnings per share to be \$5 next year. Current book value is \$4.50 per share. The discount rate is assumed to be 12 percent. If earnings are expected to grow at 4 percent forever, calculate BBB’s share price. P 0 = \$4.50 + [\$5.00 – (\$4.50 × 0.012)]/(0.12 – 0.04) = \$60.25 (b) Now assume BBB’s current earnings per share are \$5 (assume all other values do not change).

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ARE143_CHAP_6a_KEY - 1 Managerial Economics(ARE 143...

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