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b. In this situation, the expected rate of return is as follows:
r c= D1/P0 + g = $1.50/$25 + 4% = 10%. However, the required rate of return is 10.6 percent. Investors will seek to sell the
stock, dropping its price to the following:
Ö
PC =
At this point, r c= 711 $1.50
= $22.73.
0.106 0.04 $1.50
+ 4% = 10.6%, and the stock will be in equilibrium.
$22.73 D0 = $1, rS = 7% + 6% = 13%, g1 = 50%, g2 = 25%, gn = 6%.
0 rs = 13%
g1 = 50% 1.327 1 2 3     1.50 g2 = 25% g1 = 6% 4
 1.875
1.9875
+ 28.393 = 1.9875/(0.13  0.06)
= 30.268 23.704
$25.03
Answers and Solutions: 7  7 712 Calculate the dividend stream and place them on a time line. Also, calculate the price of
the stock at the end of the supernormal growth period, and include it, along with the
dividend to be paid at t = 5, as CF5. Then, enter the cash flows as shown on the time line
into the cash flow register, enter the required rate of return as I = 15, and then find the
value of the stock using the NPV calculation. Be sure to enter CF0 = 0, or else your
answer will be incorrect.
D0 = 0; D1 = 0, D2 = 0, D3 = 1.00
D4 = 1.00(1.5) = 1.5; D5 = 1.00(1.5)2 = 2.25; D6 = 1.00(1.5)2(1.08)
= $2.43.
Ö
P0 = ?
0 rs = 15% 1 2 3 g = 50% 4 5 g = 8% 6       1.00
0.66
0.86
18.38
Ö
$19.89 = P0  1.50 2.25
34.71
36.96 2.43
0.15 0.08 Ö
P5 = D6/(rs  g) = 2.43/(0.15  0.08) = 34.71. This is the price of the stock at the end of
Year 5.
CF0 = 0; CF12 = 0; CF3 = 1.0; CF4 = 1.5; CF5 = 36.96; I = 15%.
With these cash flows in the CFLO register, press NPV to get the value of the stock
today: NPV = $19.89. 713 a. Vps = b. Vps = D ps
rps = $10
= $125.
0.08 $10
= $83.33.
0.12 Answers and Solutions: 7  8 714 0  g = 5% D0 = 2.00 1 2 3 4     D1 D2 D3 D4 Ö
P3
a. D1 = $2(1.05) = $2.10. D2 = $2(1.05)2 = $2.21. D3 = $2(1.05)3 = $2.32.
b. PV = $2.10(0.8929) + $2.21(0.7972) + $2.32(0.7118) = $5.29.
Calculator solution: Input 0, 2.10, 2.21, and 2.32 into the cash flow register, input I =
12, PV = ? PV = $5.29.
c. $34.73(0.7118) = $24.72.
Calc...
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This note was uploaded on 09/14/2012 for the course MBA 341 taught by Professor Jamnadas during the Spring '12 term at LIM.
 Spring '12
 jamnadas
 Valuation

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