Question

1) Suppose you deposited $10,000 into a savings account today. The account pays a nominal annual interest rate of 12%, but interest is compounded quarterly. Assuming that you make no additional deposits into or withdrawals from the account, what will your ending balance be 10 years from today?

2) A firm expects to pay dividends at the end of each of the next four years of $2.00, $2.50, $2.50, and $3.50.  If growth is then expected to be constant at 8 percent per year forever, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock?

3)Electric Corp. just paid a $2.40 annual cash dividend. It plans to keep the future cash flows to the equity holders at this level for the foreseeable future as no future growth is expected. If the required rate of return by common stockholders is 12 percent, what is the price of this common stock?

Answer 1

1. Deposit amount = $10,000

  compounded quarterly

Annual Interest = 12%

Quarterly Interest = 12%/4= 3%

No of Years = 10

No of quarters = 10*4 = 40

Ending balance after 10 years = Future Value factor @3% for 40 periods

=$10,000*3.2620

=$32,620

Ending balance be after 10 years is $32,620

2.

Rate of Return =14%

Growth Rate from 5th year =8%

1st year dividend =$2.00

2nd year dividend =$2.50

3rd year dividend = $2.50

4th year dividend = $3.50

from 5th year dividend is growth is 8%.

As on 4th year, Present value of 5th year on wards stock value = $3.50*(1+8%)/(14%-8%)=$63

Stock Price = $2.00*0.877+$2.50*0.769+$2.50*0.675+$3.50*0.592+$63*0.592

=$1.7540+$1.9225+$1.6875+$2.0720+$37.2960

=$44.732

Willing to pay for Stock price is $44.73

3.Annual cash dividend is $2.40

Just paid dividend is $2.40

No growth in dividend

Rate of Return is 12%

Price of stock = Annual Dividend/rate of return

=$2.40/12%

=$20

Price of common stock is $20