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# Stock Valuation: Declining and Constant Growth Stock

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PREFERRED STOCK VALUATION
Fee Founders has perpetual preferred stock outstanding that sells for \$60 a share and pays a dividend of \$5 at the end of each year. What is the required rate of return?

PREFERRED STOCK VALUATION
Ezzell Corporation issued perpetual preferred stock with a 10% annual dividend. The stock currently yields 8%, and its par value is \$100.
a. What is the stock's value?
b. Suppose interest rates rise and pull the preferred stock's yield up to 12%. What is its new market value?

VALUATION OF A DECLINING GROWTH STOCK
Martell Mining Company's ore reserves are being depleted, so its sales are falling. Also, because its pit is getting deeper each year, its costs are rising. As a result, the company's earnings and dividends are declining at the constant rate of 5% per year. If D0 = \$ 5 and rs = 15%, what is the value of Martell Mining's stock?

VALUATION OF A CONSTANT GROWTH STOCK
Investors require a 15% rate of return on Levine Company's stock ( that is, rs = 15%).
a. What is its value if the previous dividend was D0 = \$2 and investors expect dividends to grow at a constant annual rate of ( 1) - 5%, ( 2) 0%, ( 3) 5%, or ( 4) 10%?
b. Using data from Part a, what would the Gordon ( constant growth) model value be if the required rate of return was 15% and the expected growth rate was ( 1) 15% or ( 2) 20%? Are these reasonable results?
c. Is it reasonable to think that a constant growth stock could have g > rs?

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#### Solution Preview

PREFERRED STOCK VALUATION
Fee Founders has perpetual preferred stock outstanding that sells for \$60 a share and pays a dividend of \$5 at the end of each year. What is the required rate of return?
Rp = Annual Dividend / P0 = \$5/\$60 = 0.08333 = 8.33%

PREFERRED STOCK VALUATION
Ezzell Corporation issued perpetual preferred stock with a 10% annual dividend. The stock currently yields 8%, and its par value is \$100.
a. What is the stock's value?
Preferred Stock Value = Annual Dividend / Yield = 10%*100/8% = \$125

b. Suppose interest rates rise and pull the preferred stock's yield up to 12%. What is its new market value? ...

#### Solution Summary

The solution outlines the financial aspects of the firms' performance to calculate the required rate of return, stock values, market values, and the expected growth rates of the companies in question.

\$2.19