Question

Investors require an 8% rate of return on Levine Company's stock (i.e., rs = 8%).

**A)** **What is its value if the previous
dividend was D0 = $2.25 and investors expect dividends to grow at a
constant annual rate of (1) -4%, (2) 0%, (3) 4%, or (4) 5%? Do not
round intermediate calculations. Round your answers to the nearest
cent.**

(1) $

(2) $

(3) $

(4) $

**B)** **Using data from part a, what would
the Gordon (constant growth) model value be if the required rate of
return was 15% and the expected growth rate was (1) 15% or (2) 20%?
Are these reasonable results?**

I. These results show that the formula does not make sense if the required rate of return is equal to or greater than the expected growth rate.

II. These results show that the formula makes sense if the required rate of return is equal to or less than the expected growth rate.

III. These results show that the formula makes sense if the required rate of return is equal to or greater than the expected growth rate.

IV. These results show that the formula does not make sense if the expected growth rate is equal to or less than the required rate of return.

V. These results show that the formula does not make sense if the required rate of return is equal to or less than the expected growth rate.

** C) Is it reasonable to think that a
constant growth stock could have g > rs?**

I. It is not reasonable for a firm to grow indefinitely at a rate higher than its required return.

II. It is reasonable for a firm to grow indefinitely at a rate higher than its required return.

III. It is not reasonable for a firm to grow even for a short period of time at a rate higher than its required return.

IV. It is not reasonable for a firm to grow indefinitely at a rate lower than its required return.

V. It is not reasonable for a firm to grow indefinitely at a rate equal to its required return.

Answer #1

P0=D0*(1+g)/(r-g)

A

1.

=2.25*(1+(-4%))/(8%-(-4%))=18

2.

=2.25*(1+(0%))/(8%-(0%))=28.125

3.

=2.25*(1+(4%))/(8%-(4%))=58.5

4.

=2.25*(1+(5%))/(8%-(5%))=78.75

B

1.

=2.25*(1+(15%))/(8%-(15%))=-36.9642857142857

2.

=2.25*(1+(20%))/(8%-(20%))=-22.5

3.

These results show that the formula does not make sense if the
required rate of return is equal to or less than the expected
growth rate.

C

It is not reasonable for a firm to grow indefinitely at a rate
higher than its required return.

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