Question

1.) Firm Y's dividend is expected to grow at a rate of 12% per year over the next 3 years and then slow to a growth rate of 4% perpetually. The company's cost of equity is 11% and the annual dividend that has just been paid was $2.95.

The estimated present value at time 2 of all future dividends beyond that point in time is?

Multiple Choice $55.06 $59.21 $67.50 $64.54

2:)

Firm Y's dividend is expected to grow at a rate of 12% per year over the next 3 years and then slow to a growth rate of 4% perpetually. The company's cost of equity is 11% and the annual dividend that has just been paid was $2.95.

What is the intrinsic value of the M Company's stock today (time 0)?

Multiple Choice

• $68.08

• $54.03

• $57.82

• $41.61

Answer 1

Q1) B) $59.21

Explanation: Cost of equity (r) = 11%

D0= 2.95

D1= 2.95 × (1.12) = 3.304

D2= 3.304 × (1.12)= 3.7005

D3= 3.7005 × (1.12)= 4.1445

D4= 4.1445 × (1.04)= 4.3103

Value at end of year 2= D3/ (1+ r)^1 + (D4/R - growth rate) / (1+r)^1

= 4.1445/(1.11)^1 + (4.3103 / 0.11 - 0.04) / (1.11)^1

= 4.1445/1.11 + (4.3103 / 0.07) / 1.11

= 3.7338 + 61.576 / 1.11

= 3.7338 + 55.4739

= $59.21

Q2) B) $54.03

Explanation: Cost of equity (r) = 11%

D0= 2.95

D1= 2.95 (1.12) = 3.304

D2= 3.304 × (1.12) = 3.7005

D3= 3.7005 × (1.12) = 4.1445

D4= 4.1445 × (1.04) = 5.3103

Value of stock at time 0

= D1/(1+r)^1 + D2/(1+r)^3 + D3/(1+r)^3 + (D4/r- growth rate) / (1+r)^3

= 3.304/(1.11)^1 + 3.7005/(1.11)^2 + 4.1445/(1.11)^3 + (4.3103/0.11 - 0.04) / (1.11)^3

= 3.304/1.11 + 3.7005/1.2321 + 4.1445 /1.3676 + (4.3103/0.07) / 1.3676

= 2.9766 + 3.0034 + 3.0305 + 61.576 / 1.3676

= 9.0099 + 45.0238

= $54.03