Question

Question1: You own a portfolio that is 25 percent invested in Stock X, 35 percent in Stock Y, and 40 percent in Stock Z. The expected returns on these three stocks are 10 percent, 13 percent, and 18 percent, respectively. What is the expected return on the portfolio?

Question 2: Johnson, Inc. has made a commitment to pay the following dividends over the next four years: $7, $13, $18, and $3.25. At the end of this four year period, the firn has further commited to grow the dividend indefinitiely at a constant 5 percent growth rate. If you require a return on this stock of 8.4 percent, what is the current share price?

Answer 1

1)

Expected Return on Portfolio = Weight1*Return1 + Weight2*Return2 + Weight3*Return3 ........

Weight of Stock X = 0.25

Weight of Stock Y = 0.35

Weight of Stock Z  = 0.40

Return of Stock X = 10 %

Return of Stock Y = 13 %

Return of Stock Z = 18%

Expected Return on the Portfolio = 0.25*10 + 0.35*13 + 0.40*18 = 14.25% Answer

2)

Year	1	2	3	4
Dividend	7	13	18	3.25+100.37
Present Value discounted @ 8.4%	7/(1+0.084)^1 =6.4576	13/(1+0.084)^2 = 11.0633	18/(1+0.084)^3 =14.1314	103.62/(1+0.084)^4 =75.0458

Terminal Value = Dividend in year 4 * (1+g) / (require return - g)

= 3.25 * (1+0.05)/ (0.084 - 0.05) = 100.37

This terminal value will be added to dividend in year 4.

Current Share price = Sum of Present value

Current Share Price = $106.70 Answer

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