Question

5 & 7

5.  Problem 9.11 (Valuation of a Constant Growth Stock)

A stock is expected to pay a dividend of $1.00 at the end of the year (i.e., D₁ = $1.00), and it should continue to grow at a constant rate of 6% a year. If its required return is 15%, what is the stock's expected price 1 year from today? Do not round intermediate calculations. Round your answer to the nearest cent.

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7.  Problem 9.14 (Nonconstant Growth)

Computech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Computech to begin paying dividends, beginning with a dividend of $1.25 coming 3 years from today. The dividend should grow rapidly - at a rate of 30% per year - during Years 4 and 5, but after Year 5, growth should be a constant 8% per year. If the required return on Computech is 12%, what is the value of the stock today? Do not round intermediate calculations. Round your answer to the nearest cent.

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Answer 1

5.Current price=D1/(Required return-Growth rate)

=1/(0.15-0.06)

=$11.11(Approx)

Hence expected price=Current price*(1+Growth rate)

=11.11*1.06

=$11.78(Approx).

7.

D3=1.25

D4=(1.25*1.3)=1.625

D5=(1.625*1.3)=2.1125

Value after year 5=(D5*Growth rate)/(Required return-Growth rate)

=(2.1125*1.08)/(0.12-0.08)

=57.0375

Hence current value=Future dividend and value*Present value of discounting factor(rate%,time period)

=1.25/1.12^3+1.625/1.12^4+2.1125/1.12^5+57.0375/1.12^5

=$35.49(Approx)