Problem 10 ABC Inc. has issued preferred stock. Preferred stock pays a constant
ID: 2616892 • Letter: P
Question
Problem 10 ABC Inc. has issued preferred stock. Preferred stock pays a constant dividend forever. ABC preferred will pay a S5 dividend forever. Investors require a 12% rate of retum on this preferred stock. What is the market price today? ANS: $41.67 Problem 11 XYZ Inc. Just paid a dividend of S345 per share. You expect dividends to grow 7% per year forever. You require a return of 18% to invest in this stock what is the ANS: $33.56 most you would be willing to pay for it today? Problem 12 GDL Inc Just paid a dividend of $4.55 per share You expect dividends to grow 15% per year for the next 3 years 10% per year for the 3 years after that, and then grow at 6% per forever. (a) Fill in the following table: Round to 2 decimal places, e.g. 56.71 Year Dividend 4 (b) If the required return on this stock is 16%, what is the price today? ANS: $65.37 (c) What is the expected price next year? ANS: $70.60Explanation / Answer
10. Price of stock when dividend in constant
Price of stock = Dividend / expected return
Dividend = $5
Expected return = 12% or 0.12
Price of stock = 5 / 0.12 = 41.666
Rounding off to two decimals
Price of stock = $ 41.67
Market price of preferred stock today is $ 41.67
11. Price of stock when dividend grows with constant rate
Price of stock = [Dividend paid in previous year (1 + growth rate)] / (expected return - growth rate)
Dividend = 3.45
Growth rate = 0.07 or 7%
Expected return = 18% or 0.18
Price of stock = [3.45 (1 + 0.07)] / (0.18 - 0.07)
= (3.45 * 1.07) / 0.11
= 3.6915 / 0.11
= 33. 559
Rounding off to two decimals
Price of stock = $33.56
12. Price of stock with multiple growth rate
a) dividend
D = Dividend of previous year * (1 + growth rate)
For first three years growth rate is 15%, for next three years it is 10% and then 6% forever.
Year 1 - D = 4.55 (1 + .15) = 4.55 * 1.15 = 5.23
Year 2 - D = 5.23 (1 + .15) = 5.23 * 1.15 = 6.02
Year 3 - D = 6.02 (1 + .15) = 6.02 * 1.15 = 6.92
Year 4 - D = 6.92 ( 1 + .10) = 6.92 * 1.10 = 7.61
Year 5 - D = 7.61 (1 + .10) = 7.61 * 1.10 = 8.37
Year 6 - D = 8.37 (1 + .10) = 8.37 * 1.10 = 9.21
Year 7 - D = 9.21 (1 + 0.06) = 9.21 * 1.06 = 9.76
b) price of stock
Expected return = 16%
Discount all the future dividends till year 6 with 16%
Present value of dividend = Dividend / (1 + expected return)^no. Of years
Present value
Year 1 - 5.23 / (1 + 0.16)^1 = 4.51
Year 2 - 6.02 / (1 + 0.16)^2 = 4.47
Year 3 - 6.92 / (1+0.16)^3 = 4.43
Year 4 - 7.61 / (1+0.16)^4 = 4.20
Year 5 - 8.37 / (1+0.16)^5 = 3.99
Year 6 - 9.21 / (1+0.16)^6 = 3.78
Add all the dividends from year 1 to year 6
Present value of dividends = 4.51+4.47+4.43+4.20+3.99+3.78 = 25.38
Present value of dividend from the year of stable growth
=Dividend / (excepted return - growth rate)
= 9.76 / (0.16 - 0.06)
= 9.76 / 0.10
= 97.6
PV = 97.6 / 1.16^6 (since it is discounted at the year end 6 that's why discounted by 6)
= 40.06
Price of stock = PV of all dividends till year 6 + PV of dividend after stable growth
Price of stock = 25.38 + 40.06 = 65.44
Price of stock today is $65.44
Note - value in decimal may vary due to rounding off.
Year Dividend 1 5.23 2 6.02 3 6.92 4 7.61 5 8.37 6 9.21 7 9.76Related Questions
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