Question

5. A broker offers to sell you shares of Bay Area Healthcare, which just paid a dividend of $2 per share. The stock's price is $30 a share. The dividend is expected to grow at a constant rate of 5% per year. The stock's required rate of return is 12%. What is the expected total return yield (this is the expected dividend yield + expected capital gains yield) for each of the next three years?

Choice: 8%

Choice: 10% C

hoice: 12%

Choice: 14%

6. Assume the risk-free rate is 6% and the market risk premium is 7%. The stock of Physicians Care Network (PCN) has a beta of 1.5. The last dividend paid by PCN (D0) was $2 per share. What would PCN's stock value be if the dividend were expected to grow at a constant rate of negative 5%.

Choice: $6.00

Choice: $8.84

Choice: $9.50

Choice: $17.60

7. Assume the risk-free rate is 5% and the market risk premium is 8%. The stock of Physicians Care Network (PCN) has a beta of 1.5. The last dividend paid by PCN (D0) was $2 per share. What would PCN's stock value be if the dividend were expected to grow at a constant rate of 0%.

Choice: $0.00

Choice: $5.05

Choice: $11.77

Choice: $20.40

8. Assume the risk-free rate is 6% and the market risk premium is 6%. The stock of Physicians Care Network (PCN) has a beta of 1.5. The last dividend paid by PCN (D0) was $2 per share. What would PCN's stock value be if the dividend were expected to grow at a constant rate of 10%.

Choice: $35.00

Choice: $40.00

Choice: $44.00

Choice: $50.00

Answer 1

Solution :

Question 5 :

Total return yield = { Dividend received over period + (Price of share at end of period - Price at the beginning of period) } / Price of share at the beginning

or = {dividend + (P1 - P0)} / P0

D0 = 2

D1 = 2+ 5%of 2 = 2.1 (dividend at year end 1)

D2 = 2.1 + 5% of 2.1 = 2.205

D3 = 2.205+ 5% of 2.205 = 2.31525

And ,

Stock price = Expected dividend (D1) / { Required rate of return , Ke - Growth rate )

Therefore stock price at year end 3 , P3 = D3 / Ke - growth rate = 2.31525 / 12% - 5% = 33.075

Total return per year = {( D1+D2+D3) +( P3 - P0) } /3 = { 2.1+2.205+2.31525 + ( 33.075 - 30) } /3 =3.23175

Total return Yield = Total return per year / Price of stock in beginning = 3.23175 /30 =10.77%

Question 6 :

Stock price = Expected dividend (D1) / { Required rate of return , Ke - Growth rate )

where,

expected dividend = Dividend paid, D0 + growth rate = $2 - 5%of $2 = $1.9

required rate of return or CAPM Return = Risk free rate of return + {Beta * Risk Premium } = 0.06 + { 1.5 * 0.07} = 16.5 %

Therefore , stock price = $1.9 / (16.5 % - (-5%) ) = 1.9 / 21.5% = $ 8.84

Question 7 :

Stock price = Expected dividend (D1) / { Required rate of return , Ke - Growth rate )

where,

expected dividend = Dividend paid, D0 + growth rate = $2 + 0 = $2

required rate of return or CAPM Return = Risk free rate of return + {Beta * Risk Premium } = 0.05 + { 1.5 * 0.08} = 17 %

Therefore , stock price = $2 / (17 % - 0 ) = 2 / 17% = $ 11.77

Question 8 :

Stock price = Expected dividend (D1) / { Required rate of return , Ke - Growth rate )

where,

expected dividend = Dividend paid, D0 + growth rate = $2 + 10% of $2 = $2.2

required rate of return or CAPM Return = Risk free rate of return + {Beta * Risk Premium } = 0.06 + { 1.5 * 0.06} = 15 %

Therefore , stock price = $2.2 / (15 % - 10 %) = 2.2 / 5% = $ 44