FIN 353 Intro to Investments Ch. 6

The dividend for Should I, Inc., is currently $1.2 per share. It is expected to grow at 20 percent next year and then decline linearly to a 5 percent perpetual rate beginning in four years. If you require a 18 percent return on the stock, what is the most you would pay per share?

$12.47 Explanation: The growth rates will be 20%, 15%, and 10% in years 1-3, with a 5% rate thereafter. D1=1.2(1.2) = $1.44 D2=1.44(1.15) = $1.656 D3=1.656 (1.1) = $1.822 D4=1.822 (1.05) = $1.913 P3= $1.913 / (0.18 - 0.05) = $14.713 P0 = $1.44/1.18 + 1.656/1.182 + $1.822/1.183 + $14.713/1.183 = $12.47

Bill's Bakery has current earnings per share of $2.5. Current book value is $4.3 per share. The appropriate discount rate for Bill's Bakery is 17 percent. Calculate the share price for Bill's Bakery if earnings grow at 3.4 percent forever.

$17.93 Explanation: P0 = $4.3 + [($2.5 × 1.034) - ($4.3 × 0.17)]/(0.17 - 0.034) = $17.93

Could I Industries just paid a dividend of $1.85 per share. The dividends are expected to grow at a 15 percent rate for the next 3 years and then level off to a 5 percent growth rate indefinitely. If the required return is 17 percent, what is the value of the stock today?

$20.73 Explanation: P0= [$1.85(1.15)/(0.17 - 0.15)][1 - (1.15/1.17)3] + [(1 + 0.15)/(1 + 0.17)]3[$1.85(1.05)/(0.17 - 0.05)] P0 = $20.73

Star Light & Power increases its dividend 4.3 percent per year every year. This utility is valued using a discount rate of 14 percent, and the stock currently sells for $43 per share. If you buy a share of stock today and hold on to it for at least three years, what do you expect the value of your dividend check to be three years from today?

$4.54 Explanation: P0 = $43 = D(1)/(0.14 - 0.043) ; D1 = $4.17 D3 = $4.17(1+ 0.043)2 = $4.54

Leisure Lodge Corporation is expected to pay the following dividends over the next four years: $21, $10, $7.2 and $2.5. Afterwards, the company pledges to maintain a constant 3 percent growth rate in dividends forever. If the required return on the stock is 15 percent, what is the current share price?

$44.25 Explanation: P4 = $2.5(1.03)/(0.15 - 0.03) = $21.46 P0 = $21/1.15 + $10/1.152 + $7.2/1.153 + ($2.5 + 21.46)/1.154 = $44.25

JJ Industries will pay a regular dividend of $0.7 per share for each of the next four years. At the end of the four years, the company will also pay out a $73 per share liquidating dividend, and the company will cease operations. If the discount rate is 10 percent, what is the current value of the company's stock?

$52.08 Explanation: P0 = $0.7/(1.1)1 + $0.7/(1.1)2 + $0.7/(1.1)3 + $0.7/(1.1)4 + $73/(1.1)4 = $52.08

You are going to value Lauryn's Doll Co. using the FCF model. After consulting various sources, you find that Lauryn has a reported equity beta of 1.5, a debt-to-equity ratio of 0.3, and a tax rate of 40 percent. Based on this information, what is Lauryn's asset beta?

1.27 Explanation: 1.5 = BAsset x(1+(0.3x(1-0.4))) BAsset = 1.27

Atlantis Seafood Company stock currently sells for $34 per share. The company is expected to pay a dividend of $2.37 per share next year, and analysts project that dividends should increase at 5 percent per year for the indefinite future. What must the relevant discount rate be for Atlantis stock?

11.97% Explanation: P0 = $34 = $2.37/(k - 0.05) , k = 11.97%

Johnson Products earned $4.4 per share last year and paid a $1.75 per share dividend. If ROE was 16 percent, what is the sustainable growth rate?

9.64% Explanation: Retention ratio = 1 - ($1.75/$4.4) = 0.602273 Sustainable growth rate = 0.16(0.602273) = 9.64%