Question

1. A drilling company reserves are depleting. Production is falling as are sales, costs are rising as production becomes more difficult, and earnings are expected to decline by 9% per year into perpetuity. The firm just paid a $10 dividend and the cost of equity is 6.5%. What is the value of the stock?

$0.00, as the estimated value was negative
		$140.00
		$58.71
		$64.52

2.

1. Stock E is currently priced at $43.44. It just paid a $1.98 dividend and has a cost of equity equal to 11%. What is the market-implied growth rate of the stock?
   • 4.78%
   • 6.16%

• • 7.44%

• • 7.26%

Answer 1

Question 1:

g = growth rate = -9%

D0 = Dividend paid = $10

D1 = Expected Dividend = D0 * (1+g) = $10 * (1-9%) = $9.1

r = cost of equity = 6.5%

Value of stock = D1 / (r - g)

= $9.1 / (6.5% +9%)

= $9.1 / 0.155

= $58.70968

Therefore, value of stock is $58.71

Question 2:

D0 = Current Dividend = $1.98

P0 = Current share price = $43.44

r = Cost of equity = 11%

Cost of equity = [D0*(1+g) / P0] + g

11% = [$1.98 * (1+g) / 43.44] + g

0.11 = 0.04558011049 + 0.04558011049 g + g

1.04558011049g = 0.0644198895

g = 0.06161162483

g = 6.16%

Therefore, implied growth rate of the stock is 6.16%