# 5 explain lg4 79 common stock valueconstant growth use

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Unformatted text preview: stocks are currently earning a 9.3% annual rate of return. a. What is the market value of the outstanding preferred stock? b. If an investor purchases the preferred stock at the value calculated in part a, how much does she gain or lose per share if she sells the stock when the required return on similar-risk preferreds has risen to 10.5%? Explain. LG4 7–9 Common stock value—Constant growth Use the constant-growth model (Gordon model) to find the value of each firm shown in the following table. Firm Dividend expected next year Dividend growth rate A \$1.20 B 4.00 5 15 C 0.65 10 14 D 6.00 8 9 E 2.25 8 20 8% Required return 13% LG4 7–10 Common stock value—Constant growth McCracken Roofing, Inc., common stock paid a dividend of \$1.20 per share last year. The company expects earnings and dividends to grow at a rate of 5% per year for the foreseeable future. a. What required rate of return for this stock would result in a price per share of \$28? b. If McCracken had both earnings growth and dividend growth at a rate of 10%, what required rate of return would result in a price per share of \$28? LG4 7–11 Common stock value—Constant growth Elk County Telephone has paid the dividends shown in the following table over the past 6 years. Year Dividend per share 2003 \$2.87 2002 2.76 2001 2.60 2000 2.46 1999 2.37 1998 2.25 344 PART 2 Important Financial Concepts The firm’s dividend per share next year is expected to be \$3.02. a. If you can earn 13% on similar-risk investments, what is the most you would be willing to pay per share? b. If you can earn only 10% on similar-risk investments, what is the most you would be willing to pay per share? c. Compare and contrast your findings in parts a and b, and discuss the impact of changing risk on share value. LG4 7–12 Common stock value—Variable growth Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned \$4.25 per share and paid cash dividends of \$2.55 per share (D0 \$2.55). Grips’ earnings and dividends are expected to grow at 25% per year for the next 3 years, after which they are expected to grow at 10% per year to infinity. What is the maximum price per share that Newman should pay for Grips if it has a required return of 15% on investments with risk characteristics similar to those of Grips? LG4 7–13 Common stock value—Variable growth Home Place Hotels, Inc., is entering into a 3-year remodeling and expansion project. The construction will have a limiting effect on earnings during that time, but when it is complete, it should allow the company to enjoy much improved growth in earnings and dividends. Last year, the company paid a dividend of \$3.40. It expects zero growth in the next year. In years 2 and 3, 5% growth is expected, and in year 4, 15% growth. In year 5 and thereafter, growth should be a constant 10% per year. What is the maximum price per share that an investor who requires a return of 14% should pay for Home Place Hotels common stock? LG4 7–14 Common st...
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