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# finance_questions_chap2_answers - 1 Metallica Bearings Inc...

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1. Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next 10 years because the firm needs to plow back its earnings to fuel growth. The company will pay a \$12 per share dividend in 11 years and will increase the dividend by 4 percent per year thereafter. If the required return on this stock is 12 percent, the current share price is \$. (Do not include the dollar sign (\$). Round your answer to 2 decimal places. (e.g., 32.16)) Explanation: Here we have a stock that pays no dividends for 10 years. Once the stock begins paying dividends, it will have a constant growth rate of dividends. We can use the constant growth model at that point. It is important to remember that general constant dividend growth formula is: P t = [D t × (1 + g )] / ( R g ) This means that since we will use the dividend in Year 11, we will be finding the stock price in Year 10. The dividend growth model is similar to the PVA and the PV of a perpetuity: The equation gives you the PV one period before the first payment. So, the price of the stock in Year 10 will be: P 10 = D 11 / ( R g ) = \$12 / (0.12 − 0.04) = \$150 The price of the stock today is simply the PV of the stock price in the future. We simply discount the future stock price at the required return. The price of the stock today will be: P 0 = \$150 / 1.12 10 = \$48.3 2. Consider four different stocks, all of which have a required return of 16 percent and a most recent dividend of \$4.50 per share. Stocks W, X, and Y are expected to maintain constant growth rates in dividends for the foreseeable future of 9 percent, 0 percent, and -8 percent per year, respectively. Stock Z is a growth stock that will increase its dividend by 24 percent for the next 2 years and then maintain a constant 10 percent growth rate thereafter. The dividend yield for Stocks W, X, Y, and Z is percent, percent, percent, and percent, respectively. The expected capital gains yield for the respective stocks is percent, percent, percent, and percent. (Do not include the percent signs (%). Negative amount should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16)) Explanation: We are asked to find the dividend yield and capital gains yield for each of the stocks. All of the stocks have a 16 percent required return, which is the sum of the dividend yield and the capital gains yield. To find the components of the total return, we need to find the stock price for each stock. Using this stock price and the dividend, we can calculate the dividend yield. The capital

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gains yield for the stock will be the total return (required return) minus the dividend yield. W: P 0 = D 0 (1 + g ) / ( R - g ) = \$4.5(1.09)/(.16 – .09) = \$70.07 Dividend yield = D 1 /P 0 = \$4.5(1.09)/\$70.07 = .07 or 7.00% Capital gains yield = .16 – .07 = .09 or 9.00% X: P 0 = D 0 (1 + g ) / ( R - g ) = \$4.5/(.16 – 0) = \$28.12 Dividend yield = D 1 /P 0 = \$4.5/\$28.12 = .16 or 16.00% Capital gains yield = .16 – .16 = 0%
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finance_questions_chap2_answers - 1 Metallica Bearings Inc...

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