Estimating the current value of a stock
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Problem 1
Suppose a dividend of $1.25 was paid. The stock has a required rate of return of 11.2% and investors expect the dividend to grow at a constant rate of 10%. Complete parts (a) through (e) below.
a) Compute D0, D1, D2, D3 and D7.
b) Compute the present value of the dividends for t = 3 years.
c) Compute the current market price.
d) Assume that the constant growth rate is actually 0%. What is the current market price?
e) Describe the behavior of the present value of each future dividend (i.e. the behavior as t increases).
Problem 2
Suppose a dividend that pays at $1.07 has a growth rate of 20% for the first 3 years. After the 3 years, there is a long-run growth rate of 8%. The stock has a required rate of return of 12.4%. Find the current market price of a share of common stock.
Problem 3
Assume the beta coefficient for a company's stock is B = 0.2, the risk-free rate of return, rRF, is 8% and the required rate of return on the market, rM, is 14%. Assume the dividend expected during the coming year is D1 = $2.50 and the growth rate is a constant 7%. Complete parts (a) through (c) below.
a) Compute the price at which the company's stock should sell.
b) Find the new price of the stock assuming the risk-free rate of return is 5% and the required rate of return on the market is 11%.
c) What would be needed for a stock to be in equilibrium?
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Solution Summary
Solution depicts the steps to estimate the current value of stock in the given cases. Calculations are carried out with the help of suitable formulas.
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Problem 1
a) Compute D0, D1, D2, D3 and D7.
Current dividend=Do=$1.25
Growth Rate=g=10%
Expected dividend to be paid at the end of year 1=D1=Do*(1+g)=1.25*(1+10%)=$1.375
Expected dividend to be paid at the end of year 2=D2=Do*(1+g)^2=1.25*(1+10%)^2=$1.5125
Expected dividend to be paid at the end of year 3=D3=Do*(1+g)^3=1.25*(1+10%)^3=$1.66375
Expected dividend to be paid at the end of year 7=D7=Do*(1+g)^7=1.25*(1+10%)^7=$2.435896
b) Compute the present value of the dividends for t = 3 years.
PV of dividend to received at the end of Year 3=PV3=D3/(1+r)^3=1.66375/(1+11.2%)^3=$1.209968
c) Compute the current market ...
Education
- BEng (Hons) , Birla Institute of Technology and Science, India
- MSc (Hons) , Birla Institute of Technology and Science, India
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