# Stock Valuation

Complete problems 1, 2, 4, 6, 9, & 11 on text pp. 296-297 of Ch. 9.

1. General Cereal common stock dividends have been growing at an annual rate

of 7 percent per year over the past 10 years. Current dividend (D0) is $1.70 per

share. What is the current value of a share of this stock to an investor who

requires a 12 percent rate of return if the following conditions exist?

a. Dividends are expected to continue growing at the historic rate for the

foreseeable future.

b. The dividend growth rate is expected to increase to 9 percent per year.

c. The dividend growth rate is expected to decrease to 6.5 percent per year.

2. The Foreman Company's earnings and common stock dividends have been

growing at an annual rate of 6 percent over the past 10 years and are expected

to continue growing at this rate for the foreseeable future. The firm currently

(D0) pays an annual dividend of $5 per share. Determine the current value of

a share of Foreman common stock to investors with each of the following

required rates of return:

a. 12 percent

b. 14 percent

c. 16 percent

d. 6 percent

e. 4 percent

4. Over the past 5 years, the dividends of the Gamma Corporation have grown

from $0.70 per share to the current level of $1.30 per share (D0). This growth

rate is expected to continue for the foreseeable future. What is the value of a

share of Gamma Corporation common stock to an investor who requires a

20 percent return on an investment?

6. The chairman of Heller Industries told a meeting of financial analysts that he

expects the firm's earnings and dividends to double over the next 6 years. The

firm's current (that is, as of year 0) earnings and dividends per share are $4

and $2, respectively.

a. Estimate the compound annual dividend growth rate over the 6-year

period.

b. Assuming the forecasted growth rate in (a) will go on forever, how much is

this stock worth today if investors require an 18 percent rate of return?

c. Why might the stock price calculated in (b) not represent an accurate

valuation to an investor with an 18 percent required rate of return?

9. Calculate the book value per share based on the reported stockholders'

equity account for Bridgford Foods in fiscal year ending November 2, 2005:

Shareholders' equity ('000)

Preferred stock, without par value

Authorized?1,000 shares

Issued and outstanding?none

Common stock, $1.00 par value $10,505

Capital in excess of par value 17,475

Retained earnings 29,355

Total shareholders' equity $57,335

11. The Kummins Engine Company common stock has a beta of 0.9. The current

risk-free rate of return is 5 percent and the market risk premium is 8 percent.

The CEO of the company is quoted in a press release as saying that the firm

will pay a dividend of $0.80/share in the coming year and expects the

dividends to grow at a constant rate of 7 percent for the foreseeable future.

Using the constant growth model, what value would you assign to this stock?

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#### Solution Preview

Complete problems 1, 2, 4, 6, 9, & 11 on text pp. 296-297 of Ch. 9.

1. General Cereal common stock dividends have been growing at an annual rate

of 7 percent per year over the past 10 years. Current dividend (D0) is $1.70 per

share. What is the current value of a share of this stock to an investor who

requires a 12 percent rate of return if the following conditions exist?

Use the dividend discount model to calculate the current value.

Current Value = D1/(Ke-g)

Where

D1 = expected dividend = D0 X (1+g)

Ke = required return

g = growth rate

a. Dividends are expected to continue growing at the historic rate for the

foreseeable future.

g=7%

Current Value = D1/(Ke-g)

D1 = 1.70 X (1+7%) = 1.819

Ke = 12%

g = 7%

Current Value =1.819/(12%-7%) = $36.38

b. The dividend growth rate is expected to increase to 9 percent per year.

g increases to 9%

Current Value = D1/(Ke-g)

D1 = 1.70 X (1+9%) = 1.853

Ke = 12%

g = 9%

Current Value =1.853/(12%-9%) = $61.77

c. The dividend growth rate is expected to decrease to 6.5 percent per year.

g decreases to 6.5%

Current Value = D1/(Ke-g)

D1 = 1.70 X (1+6.5%) = 1.810

Ke = 12%

g = 6.5%

Current Value =1.810/(12%-6.5%) = $32.92

2. The Foreman Company's earnings and common stock dividends have been

growing at an annual rate of 6 percent over the past 10 years and are expected

to continue growing at this rate for the foreseeable ...

#### Solution Summary

The solution explains various problems relating to stock valuation