QUESTION 1 A firm has dividends forecast to be $3.00 and $3.20 at the end of the

Question

QUESTION 1

A firm has dividends forecast to be $3.00 and $3.20 at the end of the next two years. Analysts also project its stock price in 2 years to be $55. If comparable risk companies have a required investor return estimated at 12%, and the stock is currently selling for $53, should an investor buy this stock?

No, rate of return (IRR) is 7.66%

Yes, rate of return (IRR) is 7.66%

Yes, rate of return (IRR) is 9.53%

Yes, rate of return (IRR) is 13.20%

QUESTION 2

A firm paid a $3.00 dividend last year and dividends are expected to grow at 15% for the next 5 years and 5% thereafter. If the required return is 13%, what is the value of a share of stock?

$54.22

$58.80

$53.86

$43.13

3.) If a company's prospects erode, it is losing money, and has negative cash flow, its stock price will never reach zero because:

Will sell for its break up value

Will sell for its cash flow value

Will sell for a zero price if cash flow is negative

Will sell for its liquidation value rather than its cash flow value

No, rate of return (IRR) is 7.66%

Yes, rate of return (IRR) is 7.66%

Yes, rate of return (IRR) is 9.53%

Yes, rate of return (IRR) is 13.20%

Explanation / Answer

a)
calculate internal rate of retun

53 = 3/(1+IRR) + 3.20/(1+IRR)^2 + 55/(1+IRR)^2

=>
IRR = 7.66%

since IRR is less than required rate of retun, should not buy this stock

hence correct choice is a)

b)

step1:

calculate dividends of next 5 years

D1 = 3 * 1.15

D2 = 3.45 * 1.15^2

D3 = 3.45 * 1.15^3

D4 = 3.45 * 1.15^4

D5 = 3.45 * 1.15^5

D6 = 3.45 * 1.15^5 * 1.05
step2:

calculate price at year 5

P5 = D6/(R-g)

= 3.45 * 1.15^5 * 1.05 / (0.13 - 0.05)

= 91.07676765

step3:
calculate present value of stock

price = present value of dividends + present value of stock price at year 5

= 3.45 * 1.15/1.13 + 3.45 * 1.15^2 /1.13^2 + 3.45 * 1.15^3 /1.13^3 + 3.45 * 1.15^4/1.13^4 + 3.45 * 1.15^5 /1.13^5 + 91.07676765/1.13^5

= $58.80

hence correct choice is b)

3)

d.  
Will sell for its liquidation value rather than its cash flow value

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