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td>>Ch 7 0 Build a Model
, 201 that must be written, only Excel formulas that use cell references or functions will be accepted for credit.
per year in recent years. This same growth rate is expected to last for another 2 years (g1 g2 = 20%).
= 0
, rs = 10%, and gn = %
, what is TTC’s stock worth today? What are its expected dividend yield and capital gains yield at this time?
20% s 1-2 only.
5% gL
=
/ P0 / – Dividend yield = P2 / P0 Cap. Gain yield= D0 $1.60 20% 5 6 Dividend = Dividend yield = D1 / P0 Cap. Gain yield= Expected return – Dividend yield / Dividend yield = / Cap. Gain yield= Expected return – Dividend yield 1.Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at 2. A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is a. The company’s dividend yield 5 years from now is expected to be 10%. b. The company’s current stock price is $20.
c. The company’s expected capital gains yield is 5%.
d. The constant growth model cannot be used because the growth rate is negative.
e. The company’s expected stock price at the beginning of next year is $9.50.
3. The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is expected to a. The stock’s dividend yield is 7%. b. The current dividend per share is $4.00.
c. The stock’s dividend yield is 8%.
d. The stock price is expected to be $54 a share one year from now.
e. The stock price is expected to be $57 a share one year from now.
4. Investors require a 16% rate of return on Brooks Sisters’ stock (rs = 16%).
a. What would the value of Brooks’s stock be if the previous dividend was D0 = $2.75 and if 1. $ b. Using data from part a, what is the Gordon (constant growth) model’s value for Brooks 1. (Yes or No)
c. Is it reasonable to expect that a constant growth stock would have g > rs? ( Yes or No)
5. Brushy Mountain Mining Company’s ore reserves are being depleted, so its sales are falling. 6. Boehm Incorporated is expected to pay a $3.70 per share dividend at the end of this year (i.e., 7. A company currently pays a dividend of $1.5 per share, D0 = 1.5. It is estimated that the 8. The beta coefficient for Stock C is bC = 0.3, and that for Stock D is bD = – 0.4. (Stock D’s beta a. If the risk-free rate is 7%and the expected rate of return on an average stock is 12%, what 1. rC = % b. For Stock C, suppose the current price, P0, is $25; the next expected dividend, D1, is I. In this situation, the expected rate of return = 8.50%. However, the required rate of return is IV. In this situation, the expected rate of return = 8.50%. However, the required rate of return is
9. The risk-free rate of return, rRF , is 12%; the required rate of return on the market, rM, 15%; and a. If the dividend expected during the coming year, D1, is $2.25, and if g is a constant b. Now, suppose the Federal Reserve Board increases the money supply, causing a fall in c. In addition to the change in part b, suppose investors’ risk aversion declines; this fact, d. Suppose Schuler has a change in management. The new group institutes policies that 10. a. $18.01 b. $17.57
c. $16.28
d. $16.70
e. $17.13
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7/22/12
Chapter 7. Ch 07 P20 Build a Model
Except for charts and answe
rs
Numeric answers in cells will not be accepted.
Rework Problem 7-19. Taussig Technologies Corporation (TTC) has been growing at a rate of
20%
=
a. If
D0
$1.
6
5
1. Find the price today.
D0 $1.60
rs
10.0%
gs
Short-run g; for
Year
gL
Long-run g; for Year 3 and all following years.
20% 5%
Year 0 1 2 3
Dividend
PV of dividends
= D3
= Terminal value = P2 =
= rs
–
=
P0
2. Find the expected dividend yield.
Recall that the expected dividend yield is equal to the next expected annual dividend divided by the price at the beginning of the period.
Dividend yield
D1
Dividend yield =
Dividend yield =
3. Find the expected capital gains yield.
The capital gains yield can be calculated by simply subtracting the dividend yield from the total expected return.
Cap. Gain yield=
Expected return
Cap. Gain yield= –
Cap. Gain yield=
Alternatively, we can recognize that the capital gains yield measures capital appreciation, hence solve for the price in one year, then divide the change in price from today to one year from now by the current price. To find the price one year from now, we will have to find the present values of the terminal value and second year dividend to time period one.
P1
+
D2
(1 + rs)
P1 = +
P1 =
Cap. Gain yield=
(P1 – P0)
Cap. Gain yield= /
b. Now assume that TTC’s period of supernormal growth is to last for 5 years rather than 2 years. How would this affect its price, dividend yield, and capital gains yield?
1. Find the price today.
rs 10.0%
gS
Short-run g; for Years 1-5 only.
gL
6%
Long-run g; for Year 6 and all following years.
20% 6%
Year 0 1 2 3
4
PV of dividends
= D6
Kenneth D. Jackson: Discounted 5 years
Kenneth D. Jackson: Discounted two years
Horizon value = P5 =
= P0
= rs – gL
Part 2. Finding the expected dividend yield.
Dividend yield = /
Dividend yield =
Part 3. Finding the expected capital gains yield.
Cap. Gain yield= –
Cap. Gain yield=
c. What will TTC’s dividend yield and capital gains yield be once its period of supernormal growth ends? (Hint: These values will be the same regardless of whether you examine the case of 2 or 5 years of supernormal growth, and the calculations are very easy.)
We used the 5-year supernormal growth scenario for this calculation, but ultimately it does not matter which example you use, as they both yield the same result.
Dividend yield =
Dn+1
Pn
Dividend yield =
Cap. Gain yield= –
Cap. Gain yield=
Upon reflection, we see that these calculations were unnecessary because the constant growth assumption holds that the long-term growth rate is the dividend growth rate and the capital gains yield, hence we could have simply subtracted the long-run growth rate from the required return to find the dividend yield.
Sheet2
7/22/12
the end of each year. The preferred stock sells for $35 a share. What is the stock’s required rate of
return? Round the answer to two decimal places.
%
expected to decline at a rate of 5% a year forever (g = −5%). If the company is in equilibrium and
its expected and required rate of return is 15%, which of the following statements is CORRECT?
grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following
statements is CORRECT?
investors expect dividends to grow at a constant compound annual rate of (1) – 4%, (2)
0%, (3) 7%, or (4) 10%? Round your answers to the nearest cent.
2. $
3. $
4. $
Sisters’s stock if the required rate of return is 16% and the expected growth rate is (1)
16% or (2) 24%? Are these reasonable results? Explain.
2. (Yes or No)
Also, its pit is getting deeper each year, so its costs are rising. As a result, the company’s earnings
and dividends are declining at the constant rate of 6% per year. If D0 = $3 and rs = 13%, what is
the value of Brushy Mountain Mining’s stock? Round your answer to the nearest cent.
$
D1 = $3.70). The dividend is expected to grow at a constant rate of 10% a year. The required rate
of return on the stock, rs, is 18%. What is the value per share of the company’s stock? Round your
answer to the nearest cent.
$
company’s dividend will grow at a rate of 19% percent per year for the next 2 years, then the
dividend will grow at a constant rate of 6% thereafter. The company’s stock has a beta equal to
1.15, the risk-free rate is 7.5 percent, and the market risk premium is 3 percent. What is your
estimate is the stock’s current price? Round your answer to the nearest cent.
$
is negative, indicating that its rate of return rises whenever returns on most other stocks fall.
There are very few negative-beta stocks, although collection agency and gold mining stocks are
sometimes cited as examples.)
are the required rates of return on Stocks C and D? Round the answers to two decimal
places.
2. rD = %
$1.50; and the stock’s expected constant growth rate is 4%. Is the stock in equilibrium?
Explain, and describe what would happen if the stock is not in equilibrium. (Choose
from the answers below: I, II, III, IV, or V)
10%. Investors will seek to buy the stock, raising its price to $33.33. At this price, the stock will
be in equilibrium.
II. In this situation, the expected rate of return = 10%. However, the required rate of return is
8.50%. Investors will seek to buy the stock, raising its price to $33.33. At this price, the stock will
be in equilibrium.
III. In this situation, the expected rate of return = 10%. However, the required rate of return is
8.50%. Investors will seek to sell the stock, raising its price to $33.33. At this price, the stock will
be in equilibrium.
10%. Investors will seek to sell the stock, raising its price to $33.33. At this price, the stock will
be in equilibrium.
V. In this situation, both the expected rate of return and the required rate of return are equal.
Therefore, the stock is in equilibrium at its current price.
Schuler Company’s stock has a beta coefficient of 1.5.
2.25%, then at what price should Schuler’s stock sell? Round your answer to the nearest
cent.
$
the risk-free rate to 6% and rM to 13%. How would this affect the price of the stock?
Round your answer to the nearest cent.
$
combined with the decline in rRF, causes rM to fall to 9%. At what price would Schuler’s
stock sell? Round your answer to the nearest cent.
$
increase the expected constant growth rate to 7%. Also, the new management stabilizes
sales and profits, and thus causes the beta coefficient to decline from 1.5 to 1.0. Assume
that rRF and rM are equal to the values in part c. After all these changes, what is Schuler’s
new equilibrium price? (Note: D1 goes to $2.35.) Round your answer to the nearest cent.
$
A share of common stock just paid a dividend of $1.00. If the expected long-run growth rate
for this stock is 5.4%, and if investors’ required rate of return is 11.4%, what is the stock price?
