Tutorial Questions
Q1) Price earning ratio = market price per share/ earning per share
= $95/$1
= 95x
As, Eps dropped to 50 and 30% dropped in EPS,
($1*70%) x 50
= $0.70 x 50
= $35
$35/$95 = 0.3684
1-0.3684 = 0.6315 (63.15%)
Thus, 63.15% dropped.
10% dropped from $35,
$35 x 90% = $31.50
PER = Market price per share/ EPS
50 = $31.50/ EPS
Thus, EPS = $0.63/ share.
Q2)
Preferred stock is many times referred to as a hybrid security. This is because preferred stock has many
characteristics of both common stock and bonds. It has characteristics of common stock: no fixed
maturity date, the non-payment of dividends does not force bankruptcy, and the non-deductibility of
dividends for tax purposes. But it is like bonds because the dividends are fixed in amount like interest
payments. From the point of view of the preferred stock shareholder, this is not the most
delightful combination. On one hand, the dividends are limited as with bonds, but the security of
forced payment by the threat of bankruptcy is not there. Thus, from the point of view of the investor, the
worst features of common stock and bonds are combined.
Q3)
a) growth rate
= ROE x retention rate
=0.115 x 0.55
=0.0633 (6.33%)
b) expected return
= ( dividend/ market price ) + growth rate
= ($3.25 / $40) + 0.0633
= 0.1496 (14.96%)
c) Since the expected return is 14.96% which is greater than your required return rate of 13%, Yes,
you should invest.
Q4)
The intrinsic value
= $12 /(7%-6%)
=$ 1200
The cost of capital :
Stock price
= 0.20(1.06)/ (0.07-0.06)
= $ 21.20