Question

 

Trump Office Supplies paid a $10 dividend last year. The dividend is expected to grow at a constant rate of 9 percent over the next four years. The required rate of return is 17 percent (this will also serve as the discount rate in this problem). Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a. Compute the anticipated value of the dividends for the next four years. (Do not round intermediate calculations. Round your final answers to 2 decimal places.) D1 D2 D3 D4

b. Calculate the present value of each of the anticipated dividends at a discount rate of 17 percent. (Do not round intermediate calculations. Round your final answers to 2 decimal places.)

D1 D2 D3 D4

c. Compute the price of the stock at the end of the fourth year (P4). (Do not round intermediate calculations. Round your final answer to 2 decimal places.) stock price at 4 years

d. Calculate the present value of the year 4 stock price at a discount rate of 17 percent. (Do not round intermediate calculations. Round your final answer to 2 decimal places.) present value of year 4 stock price

e. Compute the current value of the stock. (Do not round intermediate calculations. Round your final answer to 2 decimal places.) current value

f. Use the formula given below to show that it will provide approximately the same answer as part e. (Do not round intermediate calculations. Round your final answer to 2 decimal places.) P0 = D1 Ke − g current value

g. If current EPS were equal to $7.60 and the P/E ratio is 1.50 times higher than the industry average of 12, what would the stock price be? (Do not round intermediate calculations. Round your final answer to 2 decimal places.) stoke price

h. By what dollar amount is the stock price in part g different from the stock price in part f? (Do not round intermediate calculations. Round your final answer to 2 decimal places.) amount

i. With regard to the stock price in part f, indicate which direction it would move if:

1)D1 INCREASE

2) Ke increase

3) g increase

Answer 1

f)	As per Dividend Discount Method, current value of a stock is computed as under:
	P=D1/(Ke-g)
	where P=Current value of stock
	D1=Next years expected dividend
	r=expected rate of return
	g=growth in dividend
	In our case,D1=10*(1+.09)=			10.9
	Ke=			17%
	g=			9%
	P=	136.25

g)	EPS	=	7.6
	P/E	=	1.5*12	18
	P/E	Stock Price/EPS
	or,	Stock price=P/E*EPS
		=18*7.6
		136.8

h)

Difference between ans. f and g

=136.25-136.8

=-0.55

i)1) If D1 increases

lets assume that D1 is 10.10 instead of 10.09

then stock price would be 10.10/.08

=126.25

Hence if dividend increases stock prices decrease

2) If Ke increases

Lets assume Ke is 18% instead of 17%

then stock price would be 10.09/.10

100.9

Hence if Ke increases stock prices decrease

3) If g increases

lets assume g is 10% instead of 9%

then stock price would be 10.09/(.17-.10)

=144.14

Hence if g increases stock prices increses