Question

1.Crosby Inc. has an 11% required rate of return. It will not pay any dividend until the end of year 20 at which time it will begin to pay an annual dividend of $4.00 per share which it will hold constant thereafter. What is an estimate of the price of Crosby's stock TODAY?

A.

$5.01

B.

$36.36

C.

$4.44

D.

$32.76

2.

If Temple Lunch Trucks dividend was expected to grow at a constant rate of 5% instead of 4%, what is the most that you should be willing to pay for a share of this stock today?

A.

$52.50.

B.

$47.50

C.

$50.00

D.

$43.78

3.

True or False: Ceteris

paribus ,

dividend growth rates and stock prices are directly related.

a)True

b)False

Answer 1

1.A.$5.01.

price of the stock at the end of 19th year = D / r

since dividends are paid at the end of 20th year, we need to calculate the price of the stock at the end of 19th year first.

=> $4 /0.11

=>$36.36.

now,

the value of stock today will be = present value factor for 19 years @11% * stock price at the end of 19 years.

=>$36.36*(1 /(1+r)^n)

=>36.36*0.13767764

=>$5.01....(rounded to two decimals)

2nd question:

A.$52.50

price = D*(1+g) / (k-g)

=>$2*(1.05) / (0.09-0.05)

=>$2.10/0.04

=>$52.50.

3rd question:

True.

All else remaining same, the stock price will be higher with a higher growth rate.