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Common stock Common stock valuelong dash—Constant growth Personal Finance Problem Over the past 6 years, Elk...
Common stock
Common stock
valuelong dash—Constant
growth Personal Finance Problem Over the past 6 years, Elk County Telephone has paid the dividends shown in the following table,
LOADING...
. The firm's dividend per share in
20202020
is expected to be
$10.1210.12.
a. If you can earn
1212%
on similar-risk investments, what is the most you would be willing to pay per share in
20192019,
just after the
$9.739.73
dividend?
b. If you can earn only
99%
on similar-risk investments, what is the most you would be willing to pay per share?
c. Compare your findings in parts a and b, what is the impact of changing risk on share value
|
Year |
Dividend per share |
|
20192019 |
$9.739.73 |
|
20182018 |
$9.369.36 |
|
20172017 |
$9.009.00 |
|
20162016 |
$8.658.65 |
|
20152015 |
$8.328.32 |
|
20142014 |
$8.00 |
Solutions
Expert Solution
| To find growth rate ,g of dividends | ||
| Year | Dividends | g=(Yr.2-Yr.1)/Yr.1 |
| 2014 | 8 | |
| 2015 | 8.32 | 4.0% |
| 2016 | 8.65 | 4.0% |
| 2017 | 9 | 4.0% |
| 2018 | 9.36 | 4.0% |
| 2019 | 9.73 | 4.0% |
| 2020 | 10.12 | 4.0% |
| As we can see from the above table, the constant growth rate of dividends , over the years 2015 to 2019 is 4% |
| Hence under this constant growth rate, dividend for 2020 will be 9.73*(1+0.04)= $ 10.12 |
| a.So, to earn 12%, on similar-risk investments, the most you should be willing to pay per share in 2019-- just after the $ 9.73 dividend |
| can be found by using Grodon's constant-growth of dividend cash-flows discount model |
| where the price is the present value of growing perpetuity of dividends |
| ie.P(2019)=D2020/(Reqd. return-Growth rate of dividends) |
| ie.10.12/(12%-4%)= |
| 126.5 |
| ANSWER: The most you should be willing to pay per share in 2019, to earn 12% = $ 126.5 |
| b.To earn only 9% on similar-risk investments, the most you should be willing to pay per share in 2019-- just after the $ 9.73 dividend |
| will be just applying the above-same formula, |
| ie.10.12/(9%-4%)= |
| 202.4 |
| ANSWER: The most you should be willing to pay per share in 2019, to earn 9% return = $ 202.4 |
| c.Comparing findings in parts a and b, |
| the more the risk, the more the investor's expected return |
| the more the investor's expected return , the less the market price/value for the share |
| because he is discounting the future dividend cash flows with a larger expected return. |
| that decreases the share value. |
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