Question

Leisure Limited just paid dividend of $50 per share. The dividend is expected to grow at a constant rate of 4% a year. The required rate of return on Leisure Limited's common stock is 9% a year.

Required:

(i) What is Leisure Limited's common stock current value?

(ii) What is Leisure Limited's common stock expected price two years from now?

(b) Leisure Limited issued perpetual preferred stock with 7.5% annual dividend. The stock price is HK$115 and its par value is $100.

Required:

(i) What is the current yield of Leisure Limited's preferred stock?

(ii) Suppose the market interest rate rises and Leisure's preferred stock's yield rises to 8%. What is the price of Leisure's preferred stock then?

(c) The sales revenue of Carpe Diem Limited for 2019 is $100 million. The CEO told the sales director in December of 2019 that the board had set a target of $150 million in sales revenue for 2022 and expected that there should be stable annual growth of sales over the 3 years. The board expects the growth rate will be maintained continuously in future years. The market has the same expectation of the board. Carpe Diem Limited is expected to pay dividend of $20 per common stock at the end of the year 2020. The market price of the common stock at the beginning of 2020 is $1,000. What is the required rate of return on Carpe Diem Limited's common stock?

(d) Leisure Limited provided a loan $3,000,000 to its subsidiary Carpe Diem Limited for 5 years which is interest bearing. The annual interest rate is 12% (compound interest method). Carpe Diem Limited has to make equal quarterly payment over the five years. How much should be repaid by Carpe Diem Limited at the end of each quarter? (e) The investment return of an individual common stock can comprise dividend yield and eventual capital gain. Suppose there are two stocks: one stock with dividend payment and the other stock that does not pay any dividend. Is it possible that both stocks have the same investment returns? Please explain.

Answer 1

Answer 1 (i) $1,040

As per dividend discount model

Po = Do(1+g)/(ke-g)

Ke = Required rate of return = 9%

Do = Dividend just paid = $ 50 ; Po = Expected Market Price

g = 4%

So Po = 50(1+0.04) / (0.09 - 0.04) = 52 / 0.05 = $1,040

Answer 1 (ii)   

Expected price at the end of two year

P2 = D3 / (ke -g)

D3 = Do(1+g)^3 = 50 (1+0.04)^3 = $ 56.24

Thus Price at the end of 2 years = P2 = 56.24 / (0.09 - 0.04) =   $ 1,124.86

ANswer 2 (i)   Current Yiled = 6.52%

CUrrent Yield = Dividend in $/ Market Price

Dividend in $ = Par Value * Rate of Dividend = 7.5% * 100 = $7.5

Market Price = $ 115

Current Yiled = 7.5 / 115 = 6.52%

Answer 2 (ii)

If yield rises to 8%, then Market price will be

= Dividend Amount / Yield = 7.5 / 8% = $93.75

Answer 2 (ii)