Question

Table below to be used with problem #6 below: Variable Value Explanation Dividend growth estimate 5%, 3% 5% for 2 years (annual estimate) and 3% per year indefinitely thereafter. Current dividend $1.00 Dividend declared on 4/19/06 – to be paid to shareholders on record as of 4/28/06 Beta coefficient 2.0 Current estimate Expected market return 12.0% Historical arithmetic average (annual) return on the S&P 500 Index RFR 5.0% 10 year Treasury bond yield 6. (10 pts) Using the table above, what is the maximum that an investor should be willing to pay for the share of common stock today?

Answer 1

required rate of return	risk free rate+(market return-risk free rate)*beta	5+(12-5)*2	19
Year	Expected dividend
0	1	1
1	1*1.05	1.05
2	1.05^2	1.1025
3	1.1025*1.03	1.135575
terminal value of stock	expected dividend/(required return-risk free rate)	1.1355/(19%-3%)	7.10
Year	cash outflow	present value of cash inflow = cash inflow/(1+r)^n r =19%
1	1.05	0.882352941
2	1.1025	0.778546713
2	7.1	5.013770214
present value of share =sum of present value of cash inflow		6.67