Question

If Yumms Inc. is expected to pay dividends of $3.93 for the next seven years, and then after that the dividends are expected to grow at 1.8% thereafter. What would you be willing to pay for a share of stock if the required return is 3.8 percent?

If the risk premium for large company stocks is currently 4%, and the T-Bill rate is 2.3%, then what is the current large company stock return?

Answer 1

a.Value after year 7=(D7*Growth rate)/(Required return-Growth rate)

=(3.93*1.018)/(0.038-0.018)

=200.037

Hence current price=Future dividend and value*Present value of discounting factor(rate%,time period)

=3.93/1.038+3.93/1.038^2+3.93/1.038^3+3.93/1.038^4+3.93/1.038^5+3.93/1.038^6+3.93/1.038^7+200.037/1.038^7

=$177.84(Approx)

b.Risk premium=Stock return-Treasury bill return

Hence stock return=4+2.3

=6.3%