solnpproblec4 - CARNEGIE MELLON UNIVERSITY Tepper School of...

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Unformatted text preview: CARNEGIE MELLON UNIVERSITY Tepper School of Business Finance (70 -391) Summer 2009 Practice Problems Topic 4 Solution CONCEPT QUESTIONS 1. The solution is in the back of Brealey, Myers and Allen. 2. PV = Div 1 = ( r & g ) = 2 = ( : 12 & : 04) = $25 3. P A = Div 1 r = 10 : 1 = $100 P B = Div 1 r & g = 5 : 1 & : 04 = $83 P C = Div 1 1 : 1 1 + Div 2 1 : 1 2 + Div 3 1 : 1 3 + Div 4 1 : 1 4 + Div 5 1 : 1 5 + Div 6 1 : 1 6 + Div 7 : 1 1 1 : 1 6 P C = 5 1 : 1 1 + 6 1 : 1 2 + 7 : 2 1 : 1 3 + 8 : 64 1 : 1 4 + 10 : 37 1 : 1 5 + 12 : 44 1 : 1 6 + 12 : 44 : 1 1 1 : 1 6 P C = $104 : 50 At the capitalization rate of 10 percent, Stock C is the most valuable. For a capitalization rate of 7 percent the calculations are similar; the results are: P A = $142 : 86 P B = $166 : 67 P C = $156 : 48 and Stock B is the most valuable. 4. There are 2 reasons why the corresponding earnings-price ratios are not accurate measures of expected rates of return. (a) First, the expected rate of return will be based on future expected earnings; the price- earnings ratio reported in the press are based on past actual earnings. In general, these earnings &gures will be di/erent. (b) Second we know that: EPS 1 P = r & 1 & PV GO P and, hence, the earnings-price ratio will be equal to the expected rate of return only if PVGO is zero....
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solnpproblec4 - CARNEGIE MELLON UNIVERSITY Tepper School of...

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