Question

Practice Questions:

1A. Coolers Light SA/NV (NYSE: BUD) just paid a dividend of $3.50 per share. The company is expected to increase its next dividend by 8% and pay it out in one year. After that, dividend growth is expected to be 3% forever. What should Coolers Light stock be priced at if the required return on its stock is estimated at 9%?

A) $58.33 B) $63.00 C) $66.50 D) $71.82

2B. The volatility of Lowes share prices is 35%, and that of Dodge Ram share is also 35%. When I hold both stocks in my portfolio with an equal weight (50% in each stock), and the stock returns have a correlation of minus one, the overall volatility of returns of the portfolio is:

A) 70%


B) 35%

C) more than 35%, but below 70%

D) zero

Answer 1

FORMULA FOR CALCULATING STOCK PRICE
VALUE OF STOCK =   D1/(1+K)+(D(n+1)/(K-G)*1/(1+K)n
D1 = D0(1+G) = $3.5(1+0.08)			$       3.78
D2 = D1(1+G) = $3.78(1+0.03)			$       3.89
n = no.of years =1 year
K   = RETURN ON EQUITY
G   = GROWTH RATE
D0 = CURRENT DIVIDEND = $3.5
VALUE OF STOCK   =		$3.5(1+0.08)/(1+0.09)+$3.89/(0.09-0.03)*1/(1+0.09)
VALUE OF STOCK   =		$ 62.95	=$63

portfolio return volatality
volatality of lowes share = 0.35
volatality of dodge share = 0.35
Variance of Lowes share = ( 0.35)2
Variance of Lowes share			0.1225
sd of lowes share		Sqrt(0.1225)	0.35
Variance of dodge share = ( 0.35)2
Variance of dodge share			0.1225
sd of dodge share		Sqrt(0.1225)	0.35
portfolio return volatality		Sqrt(Variance (aX+bY))

Varaince (aX+bY) = a²*Variance of X+b²*Variance of Y+2ab*correlation*SD of X*SD of Y

=(0.5)²*0.1225+(0.5)²*0.1225+2*0.5*0.5*(-1)*0.35*0.35

=-0.06031

portfolio return volatality = SQRT(-0.06031) =-0.2445 = 0