Question

3. An investment pays the following cash flows at the end of each year for the next 4 years. The discount rate is 15 percent. Calculate the present value of the cash flows at time 0.

Year 0 1 2 3 4

CF 425 550 675 800

4.  If you use the constant growth formula for valuing a share of common stock, then an increase in the growth rate (g) will cause the price of the stock to______, if all the other variables remain unchanged.

Answer 1

3)

Statement showing PV of cash flow

Year	Cash flow	PVIF @ 15%	PV
	A	B	C = A x B
1	425	0.8696	369.57
2	550	0.7561	415.88
3	675	0.6575	443.82
4	800	0.5718	457.40
PV of cash Inflow	1686.67

Thus Present Value of the cash flows at time 0 = 1686.67$

4) Answer : Increase/rise

If growth rate is increased while other variables remains constant than stock price will increase

Let say Dividend = 2$ , required rate of return = 15% , growth rate = 5%

Price of stock = Dividend / Required rate of return - Growth rate

=2/15%-5%

=2/10%

=20$

Now lets increase growth rate to 10%

Price of stock = Dividend / Required rate of return - Growth rate

=2/15%-10%

=2/5%

=40$

Thus as g increase so does price of stock