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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?

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

$2.19