1
Managerial Economics (ARE) 143
University of California, Davis
Instructor: John H. Constantine
KEY—Chapter 6—Common Stock Valuation
Problem 1:
WorldTour 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 InTech 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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 Spring '08
 Brinkley,G
 Dividend, Dividend yield, share

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