Question

1.           Company ABC paid a dividend of $1.40 recently. Dividend growth is expected to be 8%. What should be the price of the stock if the required rate of return is 12%?

		$30.00
		$32.60
		$35.00
		$37.80

1.          Company XYZ expected to pay a dividend of $3.00 next year. Dividend growth is expected to be 6%. What should be the price of the stock today and five years from today? The required rate of return is 10%.

		$75 and $106.39
		$75.00 and $100.37
		$79.50 and $106.39
		$79.50 and $112.77

1.          A company paid a dividend of $2.50 and expects to increase dividends by 15% for the next three years before leveling off at 5%.What should be the price of the stock if the required rate of return is 16%?

		$34.42
		$30.67
		36.67
		$48.86

Answer 1

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

=(1.4*1.08)/(0.12-0.08)

=$37.80

2.

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

=3/(0.1-0.06)

=$75

We use the formula:
A=P(1+r/100)^n
where
A=future value
P=present value
r=rate of interest
n=time period.

P5=$75*(1.06)^5

=$75*1.338225578

=$100.37(Approx).

Hence the correct option is B.

3.

D1=(2.5*1.15)=$2.875

D2=(2.875*1.15)=$3.30625

D3=(3.30625*1.15)=$3.8021875

Value after year 3=(D3*Growth rate)/(Required return-Growth rate)

=(3.8021875*1.05)/(0.16-0.05)

=$36.29360795

Hence price of the stock=Future dividends*Present value of discounting factor(16%,time period)

=$2.875/1.16+$3.30625/1.16^2+$3.8021875/1.16^3+$36.29360795/1.16^3

which is equal to

=$30.67(Approx).