8. The common stock of Eddie\'s Engines, Inc. sells for $37.43 a share. The stoc

Question

8.

The common stock of Eddie's Engines, Inc. sells for $37.43 a share. The stock is expected to pay $3.40 per share next year. Eddie's has established a pattern of increasing their dividends by 5.5 percent annually and expects to continue doing so. What is the market rate of return on this stock?

18.09 percent

6.56 percent

9.08 percent

14.58 percent

11.01 percent

9.

The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 18 percent a year for the next 4 years and then decreasing the growth rate to 3 percent per year. The company just paid its annual dividend in the amount of $1.80 per share. What is the current value of one share of this stock if the required rate of return is 7.30 percent?

$85.39

$83.59

$74.05

$63.06

$72.25

12. The risk-free rate of return is 4.4 percent and the market risk premium is 14 percent. What is the expected rate of return on a stock with a beta of 1.6?

10.52 percent

26.80 percent

21.04 percent

13.40 percent

22.40 percent

Explanation / Answer

8. Stock price = Dividend next year / (Market rate of return - Dividend growth rate)

=> $37.43 = $3.40 / (Market rate of return - 5.5%)

=> Market rate of return = 14.58% which is the fourth option

9. Stock price = Dividend * (1 + dividend growth rate) / (1 + Required rate of return) + Dividend * (1 + dividend growth rate)2 / (1 + Required rate of return)2 + Dividend * (1 + dividend growth rate)3 / (1 + Required rate of return)3 + Dividend * (1 + dividend growth rate)4 / (1 + Required rate of return)4 + Dividend * (1 + dividend growth rate)4 * (1 + long term dividend growth rate) / [(1 + Required rate of return)4 * (Required rate of return - long term dividend growth rate)]

= $1.80 * (1 + 18%) / (1 + 7.30%) + $1.80 * (1 + 18%)2 / (1 + 7.30%)2 + $1.80 * (1 + 18%)3 / (1 + 7.30%)3 + $1.80 * (1 + 18%)4 / (1 + 7.30%)4 + $1.80 * (1 + 18%)4 * (1 + 3%) / [(1 + 7.30%)4 * (7.30% - 3%)]

= $72.25 which is the fifth option

12. Expected rate of return = Risk free rate + beta * Market risk premium

= 4.4% + 1.6 * 14%

= 26.80% which is the second option

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