# Preferred Stock, Values, Constant Growth Model, and WACC

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Problem 6-3

Preferred Stock. Preferred Products has issued preferred stock with an $8 annual dividend that will be paid in perpetuity.

a. If the discount rate is 12 percent, at what price should the preferred sell?

b. At what price should the stock sell 1 year from now?

c. What is the dividend yield, capital gains yield, expected rate of return of the stock?

Problem 6-10

Stock Values. Integrated Potato Chips paid a $1 per share dividend yesterday. You expect the

dividend to grow steadily at a rate of 4 percent per year.

a. What is the expected dividend in each of the next 3 years?

b. If the discount rate for the stock is 12 percent, at what price will the stock sell?

c. What is the expected stock price 3 years from now?

d. If you buy the stock and plan to hold it for 3 years, what payments will you receive?

What is the present value of those payments? Compare your answer to (b).

PMT YR1

PMT YR2

PMT YR3

PV of PMTs

Problem 6-19

Constant-Growth Model. Here are data on two stocks, both of which have discount rates of 15%:

Stock A Stock B

Return on equity 15% 10%

Earnings per share $2.00 $1.50

Dividends per share $1.00 $1.00

Stock A Stock B

a. What are the dividend payout ratios for each firm?

b. What are the expected dividend growth rates for each firm?

c. What is the proper stock price for each firm?

Problem 12-5

Calculating WACC. Reactive Industries has the following capital structure. Its corporate tax rate is 35 percent. What is its WACC?

Security Market Value Required Rate of Return

Debt $20,000,000 6.00%

Preferred stock $10,000,000 8.00%

Common stock $50,000,000 12.00%

WACC FORMULA

Problem 16-20

Dividend Policy. Here are several assertions about typical corporate dividend policies. Which of them are true?

Write out a corrected version of any false statements.

TF a. Most companies set a target dividend payout ratio.

Re-write if false.

TF b. They set each year's dividend equal to the target payout ratio times that year's earnings.

Re-write if false.

TF c. Managers and investors seem more concerned with dividend changes than dividend levels.

Re-write if false.

TF d. Managers often increase dividends temporarily when earnings are unexpectedly high for a

year or two.

Re-write if false.

Problem 16-21

Dividend Policy. For each of the following four groups of companies, state whether you would expect them to distribute a relatively high or low proportion of current earnings and whether you would expect them to have a relatively high or low price-earnings ratio.

a. High-risk companies.

b. Companies that have recently experienced a temporary decline in profits.

c. Companies that expect to experience a decline in profits.

d. "Growth" companies with valuable future investment opportunities.

#### Solution Summary

The solution calculates all the answers with some explanations for methods.