\"Elk county Telephone has paid the dividends shown in the following table over
ID: 2711017 • Letter: #
Question
"Elk county Telephone has paid the dividends shown in the following table over the previous 6 years: the firms dividend per share next year is expected to be $10.72.
A. If you can earn 12% on similar-risk investments, what is the most you would be willing to pay per share?
B. If you can earn only 9% on similar-risk investments, what is the most you would be willing to pay per share?
C. Compare your findings in parts a and b, what is the impact of changing risk on share value?"
Please answer all three parts and round to the nearest cent or by two decimal places depending on whether your answer is a dollar amount or not. The picture is the table needed.
A. If you can earn 12% on similar-risk investments, what is the most you would be willing to pay per share?
B. If you can earn only 9% on similar-risk investments, what is the most you would be willing to pay per share?
C. Compare your findings in parts a and b, what is the impact of changing risk on share value?"
Please answer all three parts and round to the nearest cent or by two decimal places depending on whether your answer is a dollar amount or not. The picture is the table needed.
Explanation / Answer
It is assumed that dividend tend to increase over time bacause business entities normally grow as time passes. Therefore if the divdend is at constat compound rate than-
For calculation of a stock price at a point of time, following formula is used.
P0 = D1/(Ke-g), where P= Price of stock aat that time, D1 = Amount of dividend to be recieved once year hence,
Ke = Cost of stock, here requird return is considered as cost of stock, g= growth rate in %
From the table & dividend expected to be after one year , growth rate is 5% {= 100 (10.72-10.21/10.21)},
hence Ke = 5%.
Using the given date of the illustration answer to ----
----(1) If you can earn 12% on similar-risk investments, what is the most you would be willing to pay per share.
P0 = D1/(Ke-g) , Present price , P0 = ? , D1 = $ 10.72, Ke = 12%, g = 5%
P0 = 10.72/ (0.12- 0.05) = 10.72/ (0.07) = 153.14, i.e. $153.14
In such scenario of 12% ke, I would like to pay maximum of $153.14 per share
(2) If you can earn 9% on similar-risk investments, what is the most you would be willing to pay per share.
P0 = D1/(Ke-g) , Present price , P0 = ? , D1 = $ 10.72, Ke = 9.00%, g = 5%
P0 = 10.72/ (0.09- 0.05) = 10.72/ (0.02) =536, i.e. $536
In such scenario of 9% ke, I would like to pay maximum of $536 per share
Q.3: Cost of equity (Ke) means return expecetd by investor, is like a burden on the company.
If ke is higher then share price is lesser as the company needs to maintained higher dividend payout ratio.
But if ke is lesser, share price is higher because the comapny would have leser divedend pay out ratio, which will result in more money available for the company to grow.
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