Question

Urban Drapers Inc., a draperies company, has been successfully doing business for the past 15 years. It went public eight years ago and has been paying out a constant dividend of $3.20 per share every year to its shareholders. In its most recent annual report, the company informed investors that it expects to maintain its constant dividend in the foreseeable future and that dividends are not expected to increase.

If you are an investor who required a 30.00% rate of return and you expect dividends to remain constant forever, what will be your valuation for Urban Draper's stock today?

Urban Drapers has a sister company named Super Carpeting Inc. Super Carpeting Inc. just paid a dividend (DoDo) of $2.40, and its dividend is expected to grow at a constant rate (g) of 5.00% per year. If the required return (r) on Super's stock is 12.5%, what is the stock price of Super's shares?

a. $19.20 per share

b. $33.60 per share

c. $32.00 per shared. $48.00 per share

Which of the following statements is true about the constant growth model?

a. The constant growth model can be used if a stock's expected constant growth is more than its required return.

b. The constant growth model can be used if a stock's expected constant growth rate is less than its required return.

Use the constant growth model to calculate the appropriate values to complete the following statements about Super Carpeting Inc.:

- If Super's stock is in equilibrium (that is, where the stock price is equal to the market value of the stock), the current expected dividend yield on the stock will be:

- Super's expected stock price one year from today will be _____ per share.

Answer 1

a) Urban Drapper Stock Price = Do/ K = $3.20/30%	$       10.67	Per share
b) Super Carpeting  stock Price = [D0 x (1 + g )]/(k - g)
Stock Price = (($2.40 x (1+5%) )/(12.5% - 5%)	$       33.60	per share
c) b. The constant growth model can be used if a stock's expected constant growth rate is less than its required return.	Correct
Explanation: The dividend growth rate must be less than the required return. If it were equal to the required return, the denominator of the constant growth formula would be zero. If it were greater than the required return, the denominator would be negative, and the stock value that you would calculate would be negative. For these reasons, the expected dividend growth rate must be less than the stock’s required return.
d)
Dividend Yield = D1/ P0 = (2.40 x 1.05)/33.60	7.50%
e)
Super's expected stock price one year from today = p1 = (D x (1+g)^2)/(k-g)
P1 = ($2.40 x (1+ 5%)^2)/(12.5%-5%)	$       36.75	per share