Question

1. You buy a stock from which you expect to receive an annual dividend of $2.50 for each of the three years that you plan on holding it. At the end of year three, you expect o be able to sell the stock for $185. What is the most that you should be willing to pay today for a share of this company if you want to earn a return of atleast 9%?

A) $68.75 B) $149.18 C) $192. 50 D) $199.33

2. Atlantic Corporation just paid an annual dividend of $1.50 per share on its common stock. Dividends are expected to grow at an annual rate of 4% hereafter. If investors require a rate of return of 8% on Atlantic stock, what is the most they should be willing to pay for a share of this stock today?

A) $18.75 B) $37.50 C) $39.00 D) $49.31

3. Pacific Corporation just paid an annual dividends $1.50 per share on its common stock. dividends are expected to grow at an annual rate of rate of 4% hereafter. if the risk- free rate is 2.5%, the MRP is 7% and Pacific's stock is only half as risky as the market average, what is the most you should be wiling to pay for a share of this stock TODAY?

A) $54.26 B) $63.17 C)$75.00 D) $78.00  

Answer 1

1)

Present value = 2.5 / (1 + 0.09)¹ + 2.5 / (1 + 0.09)² + 2.5 / (1 + 0.09)³ + 185 / (1 + 0.09)³

Present value = 2.29358 + 2.1042 + 1.93046 + 142.85394

Present value = $149.18

Most you should be willing to pay is $149.18

2)

Value of stock = D1 / Required rate - growth rate

Value of stock = (1.5 * 1.04) / 0.08 - 0.04

Value of stock = 1.56 / 0.04

Value of stock = $39.00

3)

Beta is the measure of risk

Beta of market will always be 1

therefore, beta of stock is 0.5 since stock is half as risky as market

Required return = Risk free rate + beta (market risk premium)

Required return = 2.5% + 0.5 (7%)

Required return = 6%

Value of stock = D1 / Required rate - growth rate

Value of stock = (1.5 * 1.04) / 0.06 - 0.04

Value of stock = 1.56 / 0.02

Value of stock = $78.00