karoliukas

Assume that at the end of the next year, Company A will pay a $2.00 dividend per share, an increase from the current dividend of $1.50 per share. After that, the dividend is expected to increase at a constant rate of 5%. If an investor requires a 12% return on the stock, what is the value of the stock?

A) $28.57.

B) $30.00.

C) $31.78.

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P0 = D1 / k − g
D1 = $2
g = 0.05
k = 0.12
P0 = 2 / 0.12 − 0.05 = 2 / 0.07 = $28.57

karoliukas

Company B paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of its earnings as dividends for the foreseeable future. If the firm is expected to earn a 10% return on equity in the future, and if an investor requires a 12% return on the stock, the stock’s value is closest to:

A) $12.50.

B) $17.67.

C) $16.67.

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P0 = Value of the stock = D1 / (k − g)
g = (RR)(ROE)
RR = 1 − dividend payout = 1 − 0.4 = 0.6
ROE = 0.1
g = (0.6)(0.1) = 0.06
D1 = (D0)(1 + g) = (1)(1 + 0.06) = $1.06
P0 = 1.06 / (0.12 − 0.06) = 1.06 / 0.06 = $17.67

karoliukas

Using an infinite period dividend discount model, find the value of a stock that last paid a dividend of $1.50. Dividends are expected to grow at 6 percent forever, the expected return on the market is 12 percent and the stock’s beta is 0.8. The risk-free rate of return is 5 percent.

A) $26.50.

B) $32.61.

C) $34.57.

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First find the required rate of return using the CAPM equation.
k = 0.05 + 0.8(0.12 - 0.05) = 10.6%
$1.50(1.06) /(0.106 - 0.06) = $34.57

karoliukas

A company has just paid a $2.00 dividend per share and dividends are expected to grow at a rate of 6% indefinitely. If the required return is 13%, what is the value of the stock today?

A) $34.16.

B) $32.25.

C) $30.29.

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P0 = D1 / (k - g) = 2.12 / (0.13 - 0.06) = $30.29

karoliukas

A firm is expected to have four years of growth with a retention ratio of 100%. Afterwards the firm’s dividends are expected to grow 4% annually, and the dividend payout ratio will be set at 50%. If earnings per share (EPS) = $2.4 in year 5 and the required return on equity is 10%, what is the stock’s value today?

A) $30.00.

B) $13.66.

C) $20.00.

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Dividend in year 5 = (EPS)(payout ratio) = 2.4 × 0.5 = 1.2
P4 = 1.2 / (0.1 − 0.04) = 1.2 / 0.06 = $20
P0 = PV (P4) = $20 / (1.10)4 = $13.66

karoliukas

Bybee is expected to have a temporary supernormal growth period and then level off to a “normal,” sustainable growth rate forever. The supernormal growth is expected to be 25 percent for 2 years, 20 percent for one year and then level off to a normal growth rate of 8 percent forever. The market requires a 14 percent return on the company and the company last paid a $2.00 dividend. What would the market be willing to pay for the stock today?

A) $67.50.

B) $52.68.

C) $47.09.

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First, find the future dividends at the supernormal growth rate(s). Next, use the infinite period dividend discount model to find the expected price after the supernormal growth period ends. Third, find the present value of the cash flow stream.

D1 = 2.00 (1.25) = 2.50 (1.25) = D2 = 3.125 (1.20) = D3 = 3.75
P2 = 3.75/(0.14 - 0.08) = 62.50
N = 1; I/Y = 14; FV = 2.50; compute PV = 2.19.
N = 2; I/Y = 14; FV = 3.125; compute PV = 2.40.
N = 2; I/Y = 14; FV = 62.50; compute PV = 48.09.
Now sum the PV’s: 2.19 + 2.40 + 48.09 = $52.68.

karoliukas

If a company can convince its suppliers to offer better terms on their products leading to a higher profit margin, the return on equity (ROE) will most likely:

A) increase and the stock price will increase

B) increase and the stock price will decline.

C) decrease and the stock price will increase.

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Better supplier terms lead to increased profitability. Better profit margins lead to an increase in ROE. This leads to an increase in the dividend growth rate. The difference between the cost of equity and the dividend growth rate will decline, causing the stock price to increase.

karoliukas

When a company’s return on equity (ROE) is 12% and the dividend payout ratio is 60%, what is the implied sustainable growth rate of earnings and dividends?

A) 4.0%.

B) 7.8%.

C) 4.8%.

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g = ROE × retention ratio = ROE × (1 – payout ratio) = 12 (0.4) = 4.8%

karoliukas

A company’s payout ratio is 0.45 and its expected return on equity (ROE) is 23%. What is the company’s implied growth rate in dividends?

A) 12.65%.

B) 10.35%.

C) 4.16%.

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Growth Rate = (ROE)(1 – Payout Ratio) = (0.23)(0.55) = 12.65%

karoliukas

A company’s required return on equity is 15% and its dividend payout ratio is 55%. If its return on equity (ROE) is 17% and its beta is 1.40, then its sustainable growth rate is closest to:

A) 6.75%.

B) 7.65%.

C) 9.35%.

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Growth rate = (ROE)(Retention Ratio)
= (0.17)(0.45)
= 0.0765 or 7.65%