Question

1. If a firm’s expected growth rate increases (and all else remains constant), what would you...

1. If a firm’s expected growth rate increases (and all else remains constant), what would you expect to happen to the current value of the firm’s stock?

                        A.        The value would increase.

                        B.         The value would decrease.

                        C.         The value would stay the same.

                        D.        You cannot determine what will happen to the value of the firm’s stock.

2. If a firm’s expected dividend increases (and all else remains constant), what would you expect to happen to the current value of the firm’s stock?

                        A.        The value would increase.

                        B.         The value would decrease.

                        C.         The value would stay the same.

                        D.        You cannot determine what will happen to the value of the firm’s stock.

3. Corporation recently paid a dividend of $1.60 last year and plans to grow at a constant 5 percent rate for the indefinite future. If the firm’s required return is 20 percent, what is the current price of the firm’s stock in the market?

                        A.        $11.20

                        B.         $10.67

                        C.         $9.52

                        D.        $9.07

                        E.         $16.80

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Homework Answers

Answer #1

1. The firm's value is computed as shown below:

= Current dividend (1 + growth rate) / (required rate of return - growth rate)

As can be seen if the growth rate increases, it will increase the numerator and decrease the denominator, which both will result in to increase in value of the stock.

So, the correct answer is option A.

2. The firm's value is computed as shown below:

= Expected dividend / (required rate of return - growth rate)

As can be seen if the expected dividend increases, it will increase the numerator, which will result in to increase in value of the stock.

So, the correct answer is option A.

3. The current price is computed as shown below:

= Dividend paid (1 + growth rate) / ( required rate of return - growth rate)

= $ 1.60 (1 + 0.05) / ( 0.20 - 0.05)

= $ 11.20

So, the correct answer is option A.

Feel free to ask in case of any query relating to this question

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