Problem Set 8 Solutions BUS 512B Bus 512B Problem Set 8
1. Suppose we have a non-growth stock paying a constant dividend of \$4 per
year, an example of this would be a preferred stock. If the cost of equity is
15%, what should be the price of this stock?
Based on next year’s expected dividend of \$4, and that this stock is intended to pay
this dividend in perpetuity:
\$4
PE 
 \$26.67
.15
2. Suppose you are holding a stock that just paid a \$4 dividend, has an expected
constant grow rate of 3%, and a cost of equity of 15%. What should be the
price of that stock today?
Based on next year’s expected dividend of \$4.12:
PE 
\$41.03 \$4.12

 \$34.33
.15  .03
.12
3. Suppose we have a firm that is assumed to have a dividend growth rate of
20% for the next three years, then 3% per year afterward. The cost of
equity is assumed to be 15%. Assume that the stock recently paid a dividend
of \$5. The Compute the value of the stock.
This is just the PV of the first three payments + the PV (in year 3) of the
perpetuity in growth starting in year 4, PRESENT VALUED back to year 0:
3
PE  
t 1
5  1.20
t
1.15
t



 5 1.20 3 1.03 
1


  \$48.76  16.34  \$65.10
.15  .03
1.15 3 

1