1.Great Pumpkin Farms just paid a dividend of $3.70 on its stock. The growth rat
ID: 2642455 • Letter: 1
Question
1.Great Pumpkin Farms just paid a dividend of $3.70 on its stock. The growth rate in dividends is expected to be a constant 7 percent per year indefinitely. Investors require a return of 16 percent for the first three years, a return of 14 percent for the next three years, and a return of 12 percent thereafter. What is the current share price? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Current share price $ 2. The common stock of Eddie?s Engines. Inc. sells for $43.88 a share. The stock is expected to pay $2.30 per share next year. Eddie?s has established a pattern of increasing their dividends by 4.4 percent annually and expects to continue doing so. What is the market rate of return on this stock? 9.64 percent 5.24 percent 19.08 percent 5.44 percent 12.33 percentExplanation / Answer
1 ) This stock has a constant growth rate of dividends, but the required return changes twice. To find the value of thestock today, we will begin by finding the price of the stock at Year 6, when both the dividend growth rate and therequired return are stable forever. The price of the stock in Year 6 will be the dividend in Year 7, divided by therequired return minus the growth rate in dividends. So:P
P6= D6 (1 +g ) / (R -g )
= D0(1 +g ) / (R g )=$3.70(1.07)^7/ (.12 - .07) =$118.83
Now we can find the price of the stock in Year 3. We need to find the price here since the required return changesat that time. The price of the stock in Year 3 is the PV of the dividends in Years 4, 5, and 6, plus the PV of the stock price in Year 6. The price of the stock in Year 3
p3=(3.7*(1.07)^4/1.12)+(3.5*(1.07)^5/1.12^2)+(3.5*(1.07)^6/1.12^3)+(118.83/1.14^3)
P3 =92.62
Finally, we can find the price of the stock today. The price today will be the PV of the dividends in Years 1, 2, and3, plus the PV of the stock in Year 3. The price of the stock today is:
P0=3.7*(1.07)/1.16+3.7*(1.07)^2/1.14^2+3.7*(1.07)^3/1.16^3+92.62/1.16^3
P0 =68.91
2 )
$43.88 =$2.3 / ( R -0.044)
43.88 R
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