Question

1) A stock will pay constant dividends of $6 every year. Its required rate of return (a.k.a., cost of capital, discount rate) is 23%. What is the value of the stock? Round to the penny.

2) A stock just paid a dividend of $7, and dividends will increase by 2% every year. Its required rate of return is 11%. What is the value of the stock? Round to the penny.

3) A stock will pay a dividend of $2 in one year and increase 4% every year after that. Its required rate of return is 14%. What is the value of the stock? Round to the penny.

4) PDQ Corporation is forecast to have total earnings of $1 billion next year and to pay out a total of 25% of these earnings to shareholders in the form of share repurchases and dividends. PDQ Corporation has 100 million shares outstanding. Its earnings are forecast to grow at a rate of 4% constantly. The stock's required rate of return is 10%. What is the value of a share today? Answer in dollars and round to the nearest cent.

5) What does the Total Payout Model do?

a)	Takes the sum of a stock’s dividend yield and its capital gain rate.

b)	Values shares of a firm according to the present value of the future dividends the firm will pay.

c)	Values all the firm’s equity first rather than a single share.

d)	Values a stock by viewing its dividends as a constant growth perpetuity.

Answer 1

1. Stock value = p0 = D1/r-g = 6/.23 = $26 where D1 is divided in year 1 , r is rate of return and g growth of dividend every year. In this case as it is constant dividend, the g = 0.

2. Again usingthe same formula above p0 = d1/(r-g) = 7/(11%-2%) = $77.7

3. p0 - d1/(r-g) = 2/ ( 14%-4%) = $20

4. Payout of 25% for 1B is 25M as divident, value of each share = Total stock/ no of shares = 1B/100M = $10

D1 = 25% of $10 = $2.5

p0 = d1/(r-g) = 2.5/(10%-4%) = $41.6

5. a I ttakes both stock dividend yield and capital gain