Question

The Franklin Company pays a dividend of $1.03 at t = 0.and proceeds to have a constant growth of 3.9 percent into the future. Financial analysts think the Franklin Company should have a required return of 8 percent. What should be its stock price?

Peterson Inc. is looking at a project with the following cash flows:

Year 0             $304

Year 1             $200

Year 2             $100

Year 3             $295

At cost of capital of 5 percent, what is the net present value?

Answer 1

1.The price of the stock is calculated with the help of the dividend discount model.

Price of the stock today= D1/(r-g)

where:

D1=next dividend payment

r=interest rate

g=firm’s expected growth rate

Price of the stock today= $1.03*(1 + 0.039) / 0.08 - 0.039

= $1.0702 / 0.0410

= $26.10.

2.Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= $304.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the cost of capital of 5%.
• Press the down arrow and CPT buttons to get the net present value.  

Net Present value of cash flows at 5% cost of capital is $840.01.