Dr. Sudhakar Raju
FN 3000
QUESTIONS FOR CHAPTER 7 (EQUITY MARKETS & STOCK VALUATION)
1. Money, Inc., just paid a dividend of $2.50 per share on its stock. The dividends are expected to
grow at a constant rate of 5 percent per year, indefinitely. If investors require an 11 percent return
on Money stock, what is the current price? What will the price be in three years? In 15 years?
2. The next dividend payment by No Stranger, Inc., will be $1.80 per share. The dividends are
anticipated to maintain a 6.5 percent growth rate, forever. If No Stranger stock currently sells for
$47.00 per share, what is the required return?
3. For the company in the previous problem, what is the dividend yield? What is the expected
capital gains yield?
4. Evenflow Corporation will pay $4.50 per share dividend next year. The company pledges to
increase its dividend by 4 percent per year, indefinitely. If you require a 12 percent return on your
investment, how much will you pay for the company’s stock today?
5. Mistakes, Inc., is expected to maintain a constant 6 percent growth rate in its dividends,
indefinitely. If the company has a dividend yield of 4.1 percent, what is the required return on the
company’s stock?
6. Suppose you know that a company’s stock currently sells for $60 per share and the required
return on the stock is 13 percent. You also know that the total return on the stock is evenly divided
between a capital gains yield and a dividend yield. If it is the company’s policy to always maintain a
constant growth rate in its dividends, what is the current dividend per share?
7. Beth Corp. pays a constant $15 dividend on its stock. The company will maintain this dividend for
the next eight years and will then cease paying dividends forever. If the requires return on this stock
is 11 percent, what is the current share price?
8. Legend, Inc., has an issue of preferred stock outstanding that pays a $7 dividend every year, in
perpetuity. If this issue currently sells for $90.21 per share, what is the required return?
9. The stock price of Hollis Co. is $70. Investors require a 12 percent rate of return on similar stocks.
If the company plans to pay a dividend of $4.25 next year, what growth rate is expected for the
company’s stock price?
10. E-Eyes.com has a new issue of preferred stock it calls 20/20 preferred. The stock will pay $20
dividend per year, but the first dividend will not be paid until 20 years from today. If you require a 9
percent return on this stock, how much should you pay today?
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11. Numb Corp. will pay a dividend of $3.75 next year. The company has stated that it will maintain
a constant growth rate of 5 percent a year forever. If you want a 15 percent rate of return, how
much will you pay for the stock? What if you want a 10 percent rate of return? What does this tell
you about the relationship between required return and the stock price?
12. Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over
the next six years, because the firm needs to plow back its earnings to fuel growth. The company
will then pay $7 per share dividend in year 7 and will increase the dividend by 5 percent per year
thereafter. If the required return on this stock is 13 percent, what is the current share price?
13. Hetfield and Ulrich, Inc., has an odd dividend policy. The company has just paid a dividend of $12
per share and has announced that it will increase the dividend by $5 per share for each of the next
four years, and then never pay another dividend. If you require a 12 percent return on the
company’s stock, how much will you pay for a share today?
14. Turn to Stone Corporation is expected to pay the following dividends over the next four years:
$9, $15, $17, and $3. Afterwards, the company pledges to maintain a constant 5 percent growth
rate in dividends, forever. If the required return on the stock is 11 percent, what is the current share
price?
15. Future Corp. is growing quickly. Dividends are expected to grow at a 20 percent rate for the next
three years, with the growth rate falling off to a constant 6 percent thereafter. If the required return
is 14 percent and the company just paid a $2.90 dividend, what is the current share price?
16. Antiques ‘R’ Us is a mature manufacturing firm. The company jut paid a $9 dividend but
management expects to reduce the payout by 7 percent per year, indefinitely. If you require a 10
percent return on this stock, what will you pay for a share today?
17. Tubby Corporation stock currently sells for $84 per share. The market requires a 13 percent
return on the firm’s stock. If the company maintains a constant 6 percent growth rate in dividends,
what is the most recent dividend per share paid on the stock?
18. Consider four different stocks, all of which have a required return of 18 percent and a most
recent dividend of $3.25 per share. Stocks W, X, and Y are expected to maintain constant growth
rates in dividends for the foreseeable future of 10 percent, 0 percent, and -5 percent per year,
respectively. Stock Z is a growth stock that will increase its dividends by 20 percent for the next two
years and then maintain a constant 12 percent growth rate, thereafter.
a. What is the dividend yield for each of these four stocks? What is the expected capital gains yield?
b. Discuss the relationship among the various returns that you find for each of these stocks.
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The following stock quotes appeared in The Wall Street Journal. Use the information provided to
answer Questions 19-23.
YTD %
Change
-3.4
52-week 52-week
Hi
Lo
80.25
54.64
0.0
26.16
18.85
-5.6
3.0
100.43
43.70
81.90
25.29
-7.5
38.30
29
Stock
(Sym)
Banc Corp.
BANF
DukeEngy
DUK
IBM IBM
PenneyJC
JCP
TootsieRoll
TR
Div
Yld%
PE
1.12
1.5
18
Vol
100s
13310
Close
76.33
Net
Chg
0.02
1.10
4.3
dd
22867
25.33
-0.10
.72
.50
.8
1.2
19
dd
73208
13043
93.10
42.63
-1.80
-0.43
.28
.9
26
718
??
-.061
19. Find the quote for the Banc Corp. (BANF). Assume that the dividend is constant. What was the
highest dividend yield over the past year? What was the lowest dividend yield over the past year?
20. According to the Value Line Investment Survey, the growth rate in dividends for IBM for the next five
years is expected to be 13.5 percent. Suppose IBM meets this growth rate in dividends for the next five
years and then the dividend growth rate falls to 5 percent indefinitely. Assume investors require an 11
percent return on IBM stock. Is the stock priced correctly? What factors should affect your answer?
21. According to the Value Line Investment Survey, the growth rate in dividends for Duke Energy for the
previous 10 years has been 2.5 percent. If investors feel this growth rate will continue, what is the
required return for Duke Energy stock?
22. According to the Value Line Investment Survey, the growth rate in dividends for JC Penney for the
previous 10 years has been -9.5 percent. If investors feel this growth rate will continue, what is the
required return for JC Penney stock? Does this number make sense? What are some of the potential
reasons for the negative growth in dividends?
23. What was the closing price tor Tootsie Roll on this day? The actual closing price for Tootsie Roll was
$32.05. Why is your closing price different? The Value Line Investment Survey projects a 2 percent
dividend growth rate for Tootsie Roll. What is the required return for the stock using the dividend
discount model and the actual stock price?
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