QUESTION 2 A share of stock will pay a dividend of $1.9 one year from now, with
ID: 2613268 • Letter: Q
Question
QUESTION 2
A share of stock will pay a dividend of $1.9 one year from now, with dividend growth of 5.3 percent thereafter. According to the constant dividend growth model, if the required return is 14.4 percent, what should the value of the stock be 4 years from now?
QUESTION 3
A share of stock just paid a dividend of $1.6, with an expected dividend growth of 5 percent forever. According to the constant perpetual growth model, if the required return is 14.7 percent, what should the value of the stock be 2 years from now?
QUESTION 4
If the return on equity for a firm is 14 percent and the retention ratio is 31 percent, what is the percentage sustainable growth rate of earnings and dividends?
QUESTION 5
The dividend for Weaver, Inc., is expected to grow at 16 percent for the next 4 years before leveling off at a 5.9 percent rate indefinitely. If the firm just paid a dividend of $1.05 and you require a return of 13 percent on the stock, what is the most you should pay per share?
QUESTION 6
Bill’s Bakery expects earnings per share of 5 = $5 next year. Current book value is $4 per share. The appropriate discount rate for Bill's Bakery is 12.9 percent. Calculate the share price for Bill's Bakery if earnings grow at 4.4 percent forever.
Explanation / Answer
QUESTION 2
We need to know the value as at year 4. Lets denote this as P4
Growth rate = 5.3 %; Dividend at year 1 (D1 )= 1.9 ; Rate = 14.4%
By constant growth model :
P4 = D5/(r-g)
D5 = D1 * (1+g)4 , hence D5 = 2.34
Hence P4 = 2.34 / (14.4% - 5.3%) = $25.71
Hence price at year 4 = $25.71
QUESTION 3
D0 = 1.6 ; g = 5% ; r = 14.7%
P2 = D3 /(r-g)
Or P2 = D0(1+g)3 / (14.7% - 5%)
Or P2 = 1.6(1.05)3/ (14.7% - 5%)
Or price at year 2 = $19.10
QUESTION 4
Sustainable growth rate = retention ratio * return on equity
Sustainable growth rate = 0.31 * 0.14 = 0.0434
Sustainable growth rate = 4.34%
QUESTION 5
D0 = $ 1.05
D1 = 1.05 * 1.16 = $1.22
D2 = 1.22 * 1.16 = $ 1.42
D3 = 1.42 * 1.16 = $ 1.65
D4 = 1.65 * 1.16 = $ 1.91
D5 = 1.91 * 1.059 = $ 2.02
After this the growth rate continues indefinitely. So we can calculate the terminal value at P4 and then discount this value along with dividend from D1 to D4 to get the maximum price to pay for the stock
P4 = D5 / (r - g)
So P4 = 2.02 / (0.13 – 0.059) = $28.45
Discounting the cash stream of D1 , D2 , D3 , D4 , P4 @ 13% we will get the share price as $ 21.95
QUESTION 6
P = BV + [(ROE – r) * BV]/ (r – g)
Where BV = Book Value , ROE = return on equity ; r = required rate of return ; g = growth rate
EPS = ROE * Book value
Or ROE = EPS/Book Value= 5/ 4 = 125%
P = 4 + [(1.25 – 0.129)* 4 ] / (0.129 – 0.044)
Or P = 56.75
Hence price of stock = $ 56.75