BUS 106 Chapter 7 Questions and Problems

7.2 Stock Quotes Go to finance.yahoo.com and get trading quotes for IBM. a. What are the latest stock price and market cap? b. What is the bid-ask spread? c. What are IBM's dividend payment and dividend yield? d. What is IBM's P/E ratio?

As of 5/2/2020 at 11:45 AM a. The latest stock price is $121.87 and the latest market cap is 108.207B. b. The bid-ask spread is 0.26 (121.78 - 121.52). c. IBM's dividend payment (forward dividend) is 6.48 and dividend yield is 5.16%. d. IBM's P/E ratio (TTM) is 12.07.

7.12 Dividend Discount Model Integrated Potato Chips just paid a $1 per share dividend. You expect the dividend to grow steadily at a rate of 4% per year. a. What is the expected dividend in each of the next 3 years? b. If the discount rate for the stock is 12%, at which price will the stock sell? c. What is the expected stock price 3 years from now? d. If you buy the stock and plan to sell it 3 years from now, what are your expected cash flows in (i) year 1; (ii) year 2, (iii) year 3? e. What is the present value of the stream of payments you found in part (d)? Compare your answers to part (b).

Dividends expected to grow at 4% growth rate. Recently paid dividend = $1 a. Dividend in Year 1, 2, and 3 DIV(yr. 1) = 1 x (1.04) = 1.04 DIV(yr. 2) = 1.04 x (1.04) = 1.0816 DIV(yr. 3) = 1.0816 x (1.04) = 1.1249 b. Use constant-growth dividend discount model. Price of stock today or P(0) = 1.04/(12%-4%) = $13 c. Expected stock price 3 years from now: P(3) = DIV(yr. 4) / (r-g) DIV(yr. 4) = DIV(yr. 3) x (1.04) = (1.1249) x (1.04) = 1.1699 P(3) = (1.1699) / (12%-4%) = $14.623 d. CF(yr. 0) = -13 (negative sign indicative of cash outflow, purchase price) CF(yr. 1) = 1.04 (DIV(yr. 1)) CF(yr. 2) = 1.0816 CF(yr. 3) = 1.1244864 + 14.623 (DIV(yr. 3) + selling price) = 15.748 e. PV(cashflows) = 1.04/(1+.12)^1 + 1.0816/(1+.12)^2 + 15.748/(1+.12)^3 = 13

7.4 P/E Ratios Favorita Candy's stock is expected to earn $2.40 per share this year. Its P/E ratio is 18. What is the stock price?

Favorita Candy's stock price is $43.20. P/E ratio = Market Price Per Share / Earnings Per Share (EPS) Rearrange so that: Market Price Per Share = Prices Earnings Ratio x EPS Market Price Per Share = 18 x $2.4 = $43.2 P/E ratio is the ratio of price per share to earnings per share. Higher price earnings ratio is desirable for investors.

7.8 Dividend Discount Model Rework Table 7.4 for horizon years 1, 2, 3, and 10, assuming that investors expect the dividend and stock price to increase at only 6% a year and that each investor requires the same 12% expected return. a. What value would Dritter place on the stock? b. Add a new row to Table 7.4 for a new investor, Zehnte, who has a 10-year horizon.

a. The value of per share of D is $50. b. The PV of dividends is $21.17 and the PV of terminal value is $28.83. Dividends column begins at $3 and increases at a rate of (1.06). PV(dividends) can be calculated as DIV(t)/(1.12)^(t). Terminal value is calculated as DIV(t) x (1+g)/(0.12-.0.06). PV(terminal value) is calculated as the terminal value/(1.12)^(t). Value per share is the sum of PV(dividend) and PV(terminal value).

7.11 Dividend Discount Model True or False? a. Investors will invest in a stock only if it gives a higher return than they could get elsewhere. Therefore, if a stock is fairly priced, its expected return will be greater than the cost of equity capital. b. A stock that is expected to pay a level dividend in perpetuity has a value of P(0) = DIV(1) / r. Any company that can reinvest to grow its earnings will have a greater value. c. The dividend discount model is still logically correct even for stocks that do not currently pay a dividend.

a. True b. False c. True