Question

1.If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces to:

	A.	V0= (expected dividend yield in year 1)/k.
	B.	V0= (Treasury bond yield in year 1)/k.
	C.	V0= (expected EPS in year 1)/k.
	D.	V0= (Market return in year 1)/k.

2. Linear Technology is in the high tech industry

• 2 years from now, the company expects the earnings per share (EPS)of 10¢ and payout of 50% of earnings as a dividend.
• Once profitable, earnings and dividends will grow at 15% for 5years (in years 3-7)

• From year 8, growth will be perpetual at 4%• If the required return is 20%, what are the shares currently worth?

		$0.6
		$0.37
		$0.81
		$0.10

Answer 1

1. If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces to

V0 = Expected EPS in year 1 / k (OPTION C)

2

D2= E2*50% = $0.1* 50% = $0.05

D3 = D2*1.15 = $0.0575

D4 = D3*1.15 = $0.066125
D5 = D4*1.15 =$0.07604375

D6 = D5*1.15 =$0.087450313

D7 = D6*1.15 = $0.100567859

D8 = D7*1.04 = $0.104591

Horizon value at the end of 7 years H7 = D8 /(required rate - constant growth)

= 0.104591/(0.20-0.04) = $

=$0.653691086

Current worth of shares =   0.05/1.2^2+0.0575/1.2^3+.......+0.100567859/1.2^7+0.653691086/1.2^7

=$0.37