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    Managerial Finance 476 (II)

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    27. Hunter Petroleum Corporation paid a $2 dividend last year. The dividend is expected to grow at a constant rate of 5 percent over the next three years. The required rate of return is 12 percent (this will also serve as the discount rate in this
    problem). Round all values to three places to the right of the decimal point where
    appropriate.

    a. Compute the anticipated value of the dividends for the next three years.
    That is, compute D1, D2, and D3; for example, D1 is $2.10 ($2.00 _ 1.05).

    b. Discount each of these dividends back to the present at a discount rate of 12
    percent and then sum them.

    c. Compute the price of the stock at the end of the third year (P3)...

    d. After you have computed P3, discount it back to the present at a discount
    rate of 12 percent for three years.

    e. Add together the answers in part b and part d to get P0, the current value of
    the stock. This answer represents the present value of the first three periods
    of dividends, plus the present value of the price of the stock after three periods
    (which, in turn, represents the value of all future dividends).

    f. Use Formula 10-9 to show that it will provide approximately the same answer
    as part e.

    Please see attachment for full question.

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    Solution Preview

    a. Compute the anticipated value of the dividends for the next three years.
    <br>That is, compute D1, D2, and D3; for example, D1 is $2.10 ($2.00 _ 1.05).
    <br>D1= 2*(1+5%)=2.10
    <br>D2= D1*(1+g)=2.10*(1+5%)=2.205
    <br>D3= D2*(1+g)=2.205*(1+5%)=2.315
    <br>
    <br>b. Discount each of these dividends back to the present at a discount rate of 12
    <br>percent and then sum them.
    <br>PV(D1) = D1/(1+k)= 2.10/(1+12%)=1.875
    <br>PV(D2) = ...

    $2.49

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