Tutorial

Topic 5: Stock Valuation

Question 1
Ewing systems common stock paid $1.65 in dividend last year and is expected to grow
indefinitely at an annual rate of 6%. What is the value of the stock if you require a 14% return?

Question 2
Reilly Supermarkets common stock is selling at $54, the cash dividend expected next year is
$3.78 per share, and the required rate of return is 15%. What is the implied compound growth
rate in cash dividend?

Question 3
Minos Ore reserves are depleted. Hence, the expected future rate of growth in the firms
cash dividends is -5%. The cash dividend declared recently was $4.40, and the required rate
of return is 11%. What is the current market price of the stock if we assume dividends decline
5% per year until infinity?

Question 4
Yee Energy is a new enterprise that is not expected to pay any cash dividends for the next 5
years. Its first dividend is expected to be $2, and the cash dividends are expected to grow for
the next 4 years at 25% per year. After that, cash dividends are expected to grow at a more
normal 5% per year to infinity. If the required rate of return is 18%, what is the current market
price?

Question 5
Downing Enterprise is a no-growth firm that pays cash dividends of $8 per year. Its current
required rate of return is 12%. What is Downings current market price?

Question 6
Anchor Corp. has preferred stock with an annual dividend of $3. If the required rate of return on
Anchor preferred stock is 8%, what is its price?

Question 7
Ovit, Inc. has preferred stock with a price of $20 and a dividend of $1.50 per year. What is its dividend
yield?

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Question 8
Suppose Acap Corporation will pay a dividend of $2.50 per share at the end of this year and a dividend
of $3 per share next year. You expect Acaps stock price to be $52 in two years. Assume that Acaps
equity cost of capital is 10%

a. What price would you be willing to pay for a share of Acap stock today, if you planned to hold
the stock for two years?
b. Suppose instead you plan to hold the stock for one year. For what price would you expect to
be able to sell a share of Acap stock in one year?
c. Given your answer to part (b), what price would you be willing to pay for a share of Acap stock
today, if you planned to hold the stock for one year? How does this price compare to your
answer in part (a)?

Question 9
Assume that it is at the end of Year 2016 and you are considering investing in stocks. You have
gathered the following information about the two companies that have attracted your attention. You
are required to calculate the intrinsic value of each and choose the best company to invest in.

Stock

X Y

Current dividend $1.25 $1.60

Earnings growth of dividends for the next four years 4.25% 4.32%

Expected stock price in 4 years $27.50 $31.15

Stock Price as of Dec 31, 2016 $23.35 24.21

Required return on investment 11.5% 10.5%

Question 10
Suppose that a shareholder has just paid $55 per share for XYZ company stock. The stock will pay a
dividend of $2.50 per share in the upcoming year. This dividend is expected to grow at an annual rate
of 10 percent for the indefinite future. The shareholder felt that the price she paid was an appropriate
price, given her assessment of XYZs risks. What is the annual required rate of return of this
shareholder?

Question 11
You are evaluating a stock brokers recommendation. The broker projects AT&T s stock price to be
$36 per share in three years. The most recent annual dividend was $1.20 per share. The broker
expects that dividend to grow at 7 percent annually for the next three years. The risk-free rate is 4
percent and that the market risk premium is 6 percent. The broker claims that the AT&Ts stock is
undervalued at the current price of $30.90 and its beta is 1.4; thus he strongly suggests you to buy it.
Using these assumptions, is the stock really undervalued?

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