Score: 100/100 Points 100 %

1. Award: 10 out of 10.00 points

Gilmore, Inc., just paid a dividend of $2.55 per share on its stock. The dividends are
expected to grow at a constant rate of 5.5 percent per year, indefinitely. Assume
investors require a return of 11 percent on this stock.

What is the current price? (Do not round intermediate calculations and round your
answer to 2 decimal places, e.g., 32.16.)

Current price $ 48.91

What will the price be in three years and in fifteen years? (Do not round intermediate
calculations and round your answers to 2 decimal places, e.g., 32.16.)

Price
Three years $ 57.44
Fifteen years $ 109.20

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

Gilmore, Inc., just paid a dividend of $2.55 per share on its stock. The dividends are
expected to grow at a constant rate of 5.5 percent per year, indefinitely. Assume
investors require a return of 11 percent on this stock.

What is the current price? (Do not round intermediate calculations and round your
answer to 2 decimal places, e.g., 32.16.)

Current price $ 48.91 1%

What will the price be in three years and in fifteen years? (Do not round intermediate
calculations and round your answers to 2 decimal places, e.g., 32.16.)

Price
Three years $ 57.44 1%
Fifteen years $ 109.20 1%
Explanation:

The constant dividend growth model is:

Pt = Dt (1 + g) / (R g)

So, the price of the stock today is:

P0 = D0(1 + g) / (R g)
P0 = $2.55(1.0550) / (.11 .0550)
P0 = $48.91

The dividend at Year 4 is the dividend today times the FVIF for the growth rate in
dividends and four years, so:

P3 = D3(1 + g) / (R g)
P3 = D0(1 + g)4 / (R g)
P3 = $2.55(1.0550)4 / (.11 .0550)
P3 = $57.44

We can do the same thing to find the dividend in Year 16, which gives us the price in
Year 15, so:

P15 = D15(1 + g) / (R g)
P15 = D0(1 + g)16 / (R g)
P15 = $2.55(1.0550)16 / (.11 .0550)
P15 = $109.20

There is another feature of the constant dividend growth model: The stock price grows
at the dividend growth rate. So, if we know the stock price today, we can find the
future value for any time in the future we want to calculate the stock price. In this
problem, we want to know the stock price in Year 3, and we have already calculated
the stock price today. The stock price in Year 3 will be:

P3 = P0(1 + g)3
P3 = $48.91(1 + .0550)3
P3 = $57.44

And the stock price in Year 15 will be:

P15 = P0(1 + g)15

P15 = $48.91(1 + .0550)15
P15 = $109.20
2. Award: 10 out of 10.00 points

The next dividend payment by Dizzle, Inc., will be $2.85 per share. The dividends are
anticipated to maintain a growth rate of 5.00 percent, forever.

If the stock currently sells for $49.30 per share, what is the required return? (Do not
round intermediate calculations and round your answer to 2 decimal places, e.g.,
32.16.)

Required return 10.78 %

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

The next dividend payment by Dizzle, Inc., will be $2.85 per share. The dividends are
anticipated to maintain a growth rate of 5.00 percent, forever.

If the stock currently sells for $49.30 per share, what is the required return? (Do not
round intermediate calculations and round your answer to 2 decimal places,
e.g., 32.16.)

Required return 10.78 1% %

Explanation:

We need to find the required return of the stock. Using the constant growth model, we
can solve the equation for R. Doing so, we find:

R = (D1 / P0) + g
R = ($2.85 / $49.30) + .0500
R = .1078, or 10.78%
3. Award: 10 out of 10.00 points

Take Time Corporation will pay a dividend of $4.80 per share next year. The company
pledges to increase its dividend by 7.75 percent per year, indefinitely.

If you require a return of 11 percent on your investment, how much will you pay for the
companys stock today? (Do not round intermediate calculations and round your
answer to 2 decimal places, e.g., 32.16.)

Current stock price $ 147.70

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

Take Time Corporation will pay a dividend of $4.80 per share next year. The company
pledges to increase its dividend by 7.75 percent per year, indefinitely.

If you require a return of 11 percent on your investment, how much will you pay for the
companys stock today? (Do not round intermediate calculations and round your
answer to 2 decimal places, e.g., 32.16.)

Current stock price $ 147.69 1%

Explanation:

Using the constant growth model, we find the price of the stock today is:

P0 = D1 / (R g)
P0 = $4.80 / (.11 .0775)
P0 = $147.69
4. Award: 10 out of 10.00 points

Mitchell, Inc., is expected to maintain a constant 5.3 percent growth rate in its
dividends, indefinitely.

If the company has a dividend yield of 3.8 percent, what is the required return on the
companys stock? (Do not round intermediate calculations and enter your answer
as a percent rounded to 2 decimal places, e.g., 32.16.)

Required return 9.10 %

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

Mitchell, Inc., is expected to maintain a constant 5.3 percent growth rate in its
dividends, indefinitely.

If the company has a dividend yield of 3.8 percent, what is the required return on the
companys stock? (Do not round intermediate calculations and enter your answer
as a percent rounded to 2 decimal places, e.g., 32.16.)

Required return 9.10 1% %

Explanation:

The required return of a stock is made up of two parts: The dividend yield and the
capital gains yield. So, the required return of this stock is:

R = Dividend yield + Capital gains yield

R = .0380 + .0530
R = .0910, or 9.10%
5. Award: 10 out of 10.00 points

Smiling Elephant, Inc., has an issue of preferred stock outstanding that pays a $4.80
dividend every year, in perpetuity.

If this issue currently sells for $80.00 per share, what is the required return? (Do not
round intermediate calculations and enter your answer as a percent rounded to 2
decimal places, e.g., 32.16.)

Required return 6.00 %

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

Smiling Elephant, Inc., has an issue of preferred stock outstanding that pays a $4.80
dividend every year, in perpetuity.

If this issue currently sells for $80.00 per share, what is the required return? (Do not
round intermediate calculations and enter your answer as a percent rounded to
2 decimal places, e.g., 32.16.)

Required return 6.00 1% %

Explanation:

The price of a share of preferred stock is the dividend divided by the required return.
This is the same equation as the constant growth model, with a dividend growth rate of
zero percent. Remember, most preferred stock pays a fixed dividend, so the growth
rate is zero. This is a special case of the dividend growth model where the growth rate
is zero, or the level perpetuity equation. Using this equation, we find the price per
share of the preferred stock is:

R = D / P0
R = $4.80 / $80.00
R = .0600, or 6.00%
6. Award: 10 out of 10.00 points

E-Eyes.com has a new issue of preferred stock it calls 20/20 preferred. The stock will
pay a $20 dividend per year, but the first dividend will not be paid until 20 years from
today.

If you require a return of 10.25 percent on this stock, how much should you pay today?
(Do not round intermediate calculations and round your answer to 2 decimal
places, e.g., 32.16.)

Current stock price $ 30.53

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

E-Eyes.com has a new issue of preferred stock it calls 20/20 preferred. The stock will
pay a $20 dividend per year, but the first dividend will not be paid until 20 years from
today.

If you require a return of 10.25 percent on this stock, how much should you pay today?
(Do not round intermediate calculations and round your answer to 2 decimal
places, e.g., 32.16.)

Current stock price $ 30.56 1%

Explanation:

Here, we have a stock that pays no dividends for 20 years. Once the stock begins
paying dividends, it will have the same dividends forever, a preferred stock. We value
the stock at that point, using the preferred stock equation. It is important to remember
that the price we find will be the price one year before the first dividend, so:

P19 = D20 / R
P19 = $20 / .1025
P19 = $195.12

The price of the stock today is simply the present value of the stock price in the future.
We simply discount the future stock price at the required return. The price of the stock
today will be:

P0 = $195.12 / 1.102519
P0 = $30.56
7. Award: 10 out of 10.00 points

Apocalyptica Corporation is expected to pay the following dividends over the next four
years: $6.60, $17.60, $22.60, and $4.40. Afterward, the company pledges to maintain
a constant 5.25 percent growth rate in dividends, forever.

If the required return on the stock is 7 percent, what is the current share price? (Do not
round intermediate calculations and round your answer to 2 decimal places, e.g.,
32.16.)

Current share price $ 245.20

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

Apocalyptica Corporation is expected to pay the following dividends over the next four
years: $6.60, $17.60, $22.60, and $4.40. Afterward, the company pledges to maintain
a constant 5.25 percent growth rate in dividends, forever.

If the required return on the stock is 7 percent, what is the current share price? (Do
not round intermediate calculations and round your answer to 2 decimal places,
e.g., 32.16.)

Current share price $ 245.23 1%

Explanation:

With nonconstant dividends, we find the price of the stock when the dividends level off
at a constant growth rate, and then find the present value of the future stock price,
plus the present value of all dividends during the nonconstant growth period. The
stock begins constant growth after the fourth dividend is paid, so we can find the price
of the stock at Year 4, when the constant dividend growth begins, as:

P4 = D4(1 + g) / (R g)
P4 = $4.40(1.0525) / (.07 .0525)
P4 = $264.63

The price of the stock today is the present value of the first four dividends, plus the
present value of the Year 4 stock price. So, the price of the stock today will be:

P0 = $6.60 / 1.07 + $17.60 / 1.072 + $22.60 / 1.073 + $4.40 /

1.074 + $264.63 / 1.074
P0 = $245.23
8. Award: 10 out of 10.00 points

Burton Corp. is growing quickly. Dividends are expected to grow at a rate of 31 percent
for the next three years, with the growth rate falling off to a constant 7.1 percent
thereafter.

If the required return is 12 percent and the company just paid a dividend of $2.55, what
is the current share price? (Hint: Calculate the first four dividends.) (Do not round
intermediate calculations and round your answer to 2 decimal places, e.g.,
32.16.)

Current share price $ 99.74

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

Burton Corp. is growing quickly. Dividends are expected to grow at a rate of 31

percent for the next three years, with the growth rate falling off to a constant 7.1
percent thereafter.

If the required return is 12 percent and the company just paid a dividend of $2.55,
what is the current share price? (Hint: Calculate the first four dividends.) (Do not
round intermediate calculations and round your answer to 2 decimal places,
e.g., 32.16.)

Current share price $ 99.74 1%

Explanation:

With nonconstant dividends, we find the price of the stock when the dividends level off
at a constant growth rate, and then find the present value of the future stock price,
plus the present value of all dividends during the nonconstant growth period. The
stock begins constant growth after the third dividend is paid, so we can find the price
of the stock in Year 3, when the constant dividend growth begins as:

P3 = D3(1 + g2) / (R g2)

P3 = D0(1 + g1)3(1 + g2) / (R g2)
P3 = $2.55(1.31)3(1.071) / (.12 .071)
P3 = $125.30

The price of the stock today is the present value of the first three dividends, plus the
present value of the Year 3 stock price. The price of the stock today will be:

P0 = $2.55(1.31) / 1.12 + $2.55(1.31)2 / 1.122 + $2.55(1.31)3 /

1.123 + $125.30 / 1.123
P0 = $99.74
9. Award: 10 out of 10.00 points

Gontier Corporation stock currently sells for $64.53 per share. The market requires a
return of 8 percent on the firms stock.

If the company maintains a constant 5.5 percent growth rate in dividends, what was the
most recent dividend per share paid on the stock? (Do not round intermediate
calculations and round your answer to 2 decimal places, e.g., 32.16.)

Dividend per share $ 1.53

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-01 Valuation
Assess how stock
prices depend on
future dividends
and dividend
growth.

Gontier Corporation stock currently sells for $64.53 per share. The market requires a
return of 8 percent on the firms stock.

If the company maintains a constant 5.5 percent growth rate in dividends, what was
the most recent dividend per share paid on the stock? (Do not round intermediate
calculations and round your answer to 2 decimal places, e.g., 32.16.)

Dividend per share $ 1.53 1%

Explanation:

We are given the stock price, the dividend growth rate, and the required return, and
are asked to find the dividend. Using the constant dividend growth model, we get:

P0 = D0(1 + g) / (R g)

Solving this equation for the dividend gives us:

D0 = P0(R g) / (1 + g)
D0 = $64.53(.08 .055) / (1 + .055)
D0 = $1.53
10. Award: 10 out of 10.00 points

Youve collected the following information from your favorite financial website.

52-Week Price Div PE Close Net

Hi Lo Stock (Div) Yld % Ratio Price Chg
77.40 10.43 Palm Coal .36 2.6 6 13.90 .24
55.81 33.42 Lake Lead Grp 1.54 3.8 10 40.43 .01
131.03 70.00 SIR 2.50 2.8 10 89.07 3.07
50.24 13.95 DR Dime .80 5.2 6 15.43 .26
35.00 20.74 Candy Galore .32 1.5 28 ?? .18

According to your research, the growth rate in dividends for SIR for the next five years
is expected to be 20.5 percent. Suppose SIR meets this growth rate in dividends for
the next five years and then the dividend growth rate falls to 5.5 percent indefinitely.
Assume investors require a return of 15 percent on SIR stock.

According to the dividend growth model, what should the stock price be today? (Do not
round intermediate calculations and round your answer to 2 decimal places, e.g.,
32.16.)

Current stock price $ 49.49

Based on these assumptions, is the stock currently overvalued, undervalued, or

correctly valued?

Overvalued

References

Worksheet Learning Section: 7.1 Common Stock

Objective: 07-03 Valuation
Explain how the
stock markets
work.

Youve collected the following information from your favorite financial website.

52-Week Price Div PE Close Net

Hi Lo Stock (Div) Yld % Ratio Price Chg
77.40 10.43 Palm Coal .36 2.6 6 13.90 .24
55.81 33.42 Lake Lead Grp 1.54 3.8 10 40.43 .01
131.03 70.00 SIR 2.50 2.8 10 89.07 3.07
50.24 13.95 DR Dime .80 5.2 6 15.43 .26
35.00 20.74 Candy Galore .32 1.5 28 ?? .18
According to your research, the growth rate in dividends for SIR for the next five years
is expected to be 20.5 percent. Suppose SIR meets this growth rate in dividends for
the next five years and then the dividend growth rate falls to 5.5 percent indefinitely.
Assume investors require a return of 15 percent on SIR stock.

According to the dividend growth model, what should the stock price be today? (Do
not round intermediate calculations and round your answer to 2 decimal places,
e.g., 32.16.)

Current stock price $ 49.48 1%

Based on these assumptions, is the stock currently overvalued, undervalued, or

correctly valued?

Overvalued

Explanation:

With nonconstant dividends, we find the price of the stock when the dividends level off
at a constant growth rate, and then find the present value of the future stock price,
plus the present value of all dividends during the nonconstant growth period. Since the
first dividend with constant growth is in Year 6, we can find the price of the stock in
Year 5, one year before the constant dividend growth begins as:

P5 = D6 / (R g)
P5 = D0(1 + g1)5(1 + g2) / (R g2)
P5 = $2.50(1.205)5(1.0550) / (.15 .0550)
P5 = $70.53

The price of the stock today is the present value of the first five dividends, plus the
present value of the Year 5 stock price. The price of the stock today will be:

P0 = $2.50(1.205) / 1.15 + $2.50(1.205)2 / 1.152 + $2.50(1.205)3

/ 1.153 + $2.50(1.205)4 / 1.154 + $2.50(1.205)5 / 1.155 + $70.53
/ 1.155
P0 = $49.48

According to the constant growth model, the stock seems to be overvalued.