Question

In: Accounting

Question 1: Assume that it is now January 1, 2010. ABC is experiencing is using all...

Question 1:

Assume that it is now January 1, 2010. ABC is experiencing is using all the earnings for expansion and therefore, has no dividends. The company will pay a dividend of $1.5 coming 4 years from today. The dividends are expected to grow at a super-normal growth rate of 20% for year 5 and year 6, after which the company achieves a long run growth rate of 6%. Stockholders require a return of 12%.

a. Calculate ABC's non-constant dividends from year 1 to year 6. Also make a time-line.

b. Calculate ABC's horizon value.

c. Calculate the value of the stock today, P̂0.

d. Calculate the expected dividend yield, capital gains yield, and total return expected for 2010.

Solutions

Expert Solution

a. Timeline

Dividend Payment Schedule
Year Dividend Growth Rate
1             1.50                      -  
2           1.50                      -  
3             1.50                      -  
4           1.50                      -  
5           1.80 20%
6           2.16 20%
7           2.29 6% (Constant thereafter)

b. Calculation of ABC's Horizon Value

The value of share of a company at the point after which we expect stable growth rate forever i.e P6.

Therefore, the Horizon Value is $38.16.

c. Calculation of Value of stock today:

To calculate the price of stock today, we need to discount the horizon value and dividends from Year 1-6 today that is January 1, 2010.

Present Value Schedule
Year Dividend Horizon Value Present Value Factor @ 12% Present Value
1           1.50                          -   0.892857143                     1.34
2           1.50 0.797193878                     1.20
3           1.50 0.711780248                     1.07
4           1.50 0.635518078                     0.95
5           1.80 0.567426856                     1.02
6           2.16                   38.16 0.506631121                   20.43
                  26.00

d.

  • Expected Dividend Yield for the year 2010:

Therefore Expected Dividend Yield is 5.77%

  • Capital Gains yield

Expected price of Stock on January 1,2011.

Present Value Schedule
Year Dividend Horizon Value Present Value Factor @ 12% Present Value
1           1.50 0.892857143                     1.34
2           1.50 0.797193878                     1.20
3           1.50 0.711780248                     1.07
4           1.80 0.635518078                     1.14
5           2.16                   38.16 0.567426856                   22.88
                  27.63

Therefore, Capital gains yield will be 6.27%.

  • Total return Expected for Year 2010:

Therefore, Total return expected for the Year 2010 will be 12.04%.


Related Solutions

Question 1: Assume that it is now January 1, 2010. ABC is experiencing is using all...
Question 1: Assume that it is now January 1, 2010. ABC is experiencing is using all the earnings for expansion and therefore, has no dividends. The company will pay a dividend of $1.5 coming 4 years from today. The dividends are expected to grow at a super-normal growth rate of 20% for year 5 and year 6, after which the company achieves a long run growth rate of 6%. Stockholders require a return of 12%. a. Calculate ABC's non-constant dividends...
Assume it is now 1 January: ABC Ltd will be arranging a six-month, $10M loan at...
Assume it is now 1 January: ABC Ltd will be arranging a six-month, $10M loan at an interest rate based on six-months LIBOR to commence, in 6 month’s time, on July 1st. ABC Ltd wishes to hedge against an increase in interest on this loan by using an FRA. Hence on 1 January the company buys a six-twelve FRA from the bank at 8%. Calculate the amount payable by the company or the bank if on the settlement date, which...
Assume that it is now January 1, 2001 and you will need $1,000 on January 1,...
Assume that it is now January 1, 2001 and you will need $1,000 on January 1, 2005. Your bank compounds interest rate at an 8 per cent annual rate. I. How much must you deposit of January 1, 2002, have a balance of $1,000 on January 1, 2005? II. If you want to make equal payments on each January 1 from 2002 through 2005 to accumulate the $1,000, how large must each of the 4 payments be? III. If your...
** Please answer all parts and explain! 1. Assume the economy is currently experiencing a recessionary...
** Please answer all parts and explain! 1. Assume the economy is currently experiencing a recessionary gap. a. How should the Fed use the three monetary policy tools to close this gap? (0.6 point) b. What will happen to money supply, AD, AD curve, aggregate output (real GDP), and the price level when the above policy tools are used? Explain. (0.6 point) 2. a. What is the equation of exchange? (0.1 point) b. What does the quantity theory of money...
14-2 Assume that it is now January 1, 2008. The rate of inflation is expected to...
14-2 Assume that it is now January 1, 2008. The rate of inflation is expected to be 2 percent throughout 2008. In 2009 and after, increased government deficits and renewed vigor in the economy are expected to push inflation rates higher. Investors expect the inflation rate to be 3 percent in 2009, 5 percent in 2010, and 6 percent in 2011. The real risk-free rate, r*, currently is 3 percent. Assume that no maturity risk premiums are required on bonds...
QUESTION 14 Please use the following question to answer questions 14-20: On January 1, 2010, P...
QUESTION 14 Please use the following question to answer questions 14-20: On January 1, 2010, P Company purchased an 80% interest in S Company for $900,000. At that time, S Company had capital stock of $600,000 and retained earnings of $100,000. Differences between the fair value and the book value of the identifiable assets of Salem Company were as follows: Fair Value in Excess of Book Value Equipment $       180,000 Land             20,000 Inventory             20,000 The book values of all other assets...
Assume that on January 1, year 1, ABC Inc. issued 5,000 stock options with an estimated...
Assume that on January 1, year 1, ABC Inc. issued 5,000 stock options with an estimated value of $10 per option. Each option entitles the owner to purchase one share of ABC stock for $25 a share (the per share price of ABC stock on January 1, year 1, when the options were granted). The options vest at the end of the day on December 31, year 2. All 5,000 stock options were exercised in year 3 when the ABC...
Question (1) On January 1, 2010, XYZ Co purchased equipment for $550,000. XYZ expects the equipment...
Question (1) On January 1, 2010, XYZ Co purchased equipment for $550,000. XYZ expects the equipment to remain useful for 5 years and to have a residual value of $50,000. The company uses the straight line method to depreciate its equipment. The company sold the equipment on January 1, 2012 for $370,000 for cash. Required: Compute the annual Depreciation expense for each of 2010 and 2011. 2A: Record the journal entry for Depreciation in 2011. Date Accounts DR CR 12/31/2011...
4. Assume a company's January 1, 2010, financial position was: Assets, $75,000 and Liabilities, $30,000. During...
4. Assume a company's January 1, 2010, financial position was: Assets, $75,000 and Liabilities, $30,000. During January 2010, the company completed the following transactions: (a) paid on a note payable $5,000; (b) collected an accounts receivable, $4,000; (c) paid an accounts payable, $3,000; and (d) purchased a truck using $2,000 cash, and a $13,000 note payable. The company's January 31, 2010 financial position is Assets Liabilities Stock holders equity A) $83,000 $38,000 $45,000 B) $65,000 $35,000 $30,000 C) $78,000 $37,000...
Assume today is the beginning of year 2011, i.e., January 1, 2011. Company ABC is a...
Assume today is the beginning of year 2011, i.e., January 1, 2011. Company ABC is a hi-tech start-up company that had total after tax earnings of $ 2 million in 2010. Of these, $500,000 were paid out as a dividend to shareholders on December 31, 2010, and the remaining dividends are invested to finance future growth. Company ABC has a total number of 1,000,000 shares outstanding so that the dividend per share is $0.5. ABC’s earnings will grow at a...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT