invic

If a stock expects to pay dividends of $2.30 per share next year, what is the value of the stock if the required rate of return is 12% and the expected growth rate in dividends is 4%?

A) $28.75.

B) $29.90.

C) $19.17.

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Using the Gordon growth model, the value per share = DPS1 / (r − g) = 2.30 / (0.12 − 0.04) = $28.75.

invic

An investor projects that a firm will pay a dividend of $1.00 next year and $1.20 the following year. At the end of the second year, the expected price of the shares is $22.00. If the required return is 14%, what is the current value of the firm’s shares?

A) $15.65.

B) $19.34.

C) $18.73.

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The current value of the shares is $18.73:

V0 = $1.00 / 1.14 + $1.20 / (1.14)2 + $22.00 / (1.14)2 = $18.73

invic

An investor projects that a firm will pay a dividend of $1.25 next year, $1.35 the second year, and $1.45 the third year. At the end of the third year, she expects the asset to be priced at $36.50. If the required return is 12%, what is the current value of the shares?

A) $32.78.

B) $29.21.

C) $31.16.

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The current value of the shares is $29.21: V0 = ($1.25 / 1.12) + ($1.35 / (1.12)2) + ($1.45 / (1.12)3) + ($36.50 / (1 + 0.12)3) = $29.21

invic

JAD just paid a dividend of $0.80. Analysts expect dividends to grow at 25% in the next two years, 15% in years three and four, and 8% for year five and after. The market required rate of return is 10%, and Treasury bills are yielding 4%. JAD has a beta of 1.4. The estimated current price of JAD is closest to:

A) $45.91.

B) $25.42.

C) $29.34.

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JAD’s stock price today can be calculated using the three-stage model. Start by finding the value of the dividends for the next four years with the two different dividend growth rates.

D1 = D0(1+g) = $0.80(1.25) = $1.00
D2 = D1(1+g) = $1.00(1.25) = $1.25
D3 = D2(1+g) = $1.25(1.15) = $1.4375
D4 = D3(1+g) = $1.4375(1.15) = $1.6531

(Alternatively, you could use your financial calculators to solve for the future value to find D1, D2, D3, and D4.)
Next find the value of the stock at the beginning of the constant growth period using the constant dividend discount model:

The easiest way to proceed is to use the NPV function in the financial calculator.
CF0 = 0; CF1 = 1.00; CF2 = 1.25; CF3 = 1.4375; CF4 = 1.6531 + 40.57 = 42.22
I = 12.4; NPV = 29.34
The value of the firm today is $29.34 per share.

invic

IAM, Inc. has a current stock price of $40.00 and expects to pay a dividend in one year of $1.80. The dividend is expected to grow at a constant rate of 6% annually. IAM has a beta of 0.95, the market is expected to return 11%, and the risk-free rate of interest is 4%. The expected stock price two years from today is closest to:

A) $43.49.

B) $41.03.

C) $43.94.

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invic

A firm's dividend per share in the most recent year is $4 and is expected to grow at 6% per year forever. If its shareholders require a return of 14%, the value of the firm's stock (per share) using the single-stage dividend discount model (DDM) is:

A) $50.00.

B) $53.00.

C) $28.57.

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The value of the firm's stock is: $4 × [1.06 / (0.14 − 0.06)] = $53.00

invic

Jand, Inc., currently pays a dividend of $1.22, which is expected to grow at 5%. If the current value of Jand’s shares based on the Gordon model is $32.03, what is the required rate of return?

A) 8%.

B) 9%.

C) 7%.

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The required return is 9%: r = [$1.22(1 + 0.05) / $32.03] + 0.05 = 0.09 or 9%.

invic

A firm currently pays a dividend of $1.77, which is expected to grow at a rate of 4%. If the required return is 10%, what is the current value of the shares using the Gordon growth model?

A) $29.76.

B) $30.68.

C) $29.50.

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The current value of the shares is $30.68:

V0 = [$1.77(1 + 0.04)] / (0.10 – 0.04)] = $30.68

invic

Jax, Inc., pays a current dividend of $0.52 and is projected to grow at 12%. If the required rate of return is 11%, what is the current value based on the Gordon growth model?

A) $58.24.

B) unable to determine value using Gordon model.

C) $39.47.

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The Gordon growth model cannot be used if the growth rate exceeds the required rate of return.

invic

A company reports January 1, 2002, retained earnings of $8,000,000, December 31, 2002, retained earnings of $10,000,000, and 2002 net income of $5,000,000. The company has 1,000,000 shares outstanding and dividends are expected to grow at a rate of 5% per year. What is the expected dividend at the end of 2003?

A) $3.15.

B) $3.00.

C) $13.65.

The first step is to determine 2002 dividends paid as ($8,000,000 + $5,000,000 − 10,000,000) = $3,000,000. The next step is to find the dividend per share ($3,000,000 / 1,000,000 shares) = $3.00 per share. Applying the 5% growth rate, next year’s expected dividend is $3.15, or $3.00 × 1.05.