Investment Analysis: Course Notes
Investment Analysis (FIN 670)
Fall 2009
Homework 8
Instructions: please read carefully
•
•
You should show your work how to get the answer for each calculation question to get full credit The due date is Tue Dec 15, 2009. Late homework will not be graded.
Name(s):
Student ID
1. A constant-growing stock just paid $2 dividend and has a current market price of $30. Determine the stock's required rate of return if the company's constant growth rate is 5%.
a. 5%
b. 7%
c. 12%
d. 14%
1. c
R = D1/Po + g = 2(1+0.05)/30 + 0.05 = 0.12
2. Stock analysts just predicted that Hybrid Engine Company's earnings and dividends will grow at 20% each year for the next two years due to its new invention. After that, its growth rate will stabilize at
5% per year indefinitely. Assume that the rate of return on the stock is 14% and its last dividend was
$1 per share. Determine the current price of the company's stock.
a. $16.8
b. $15.1
c. $16.1
d. $13.8
2. b
Step 1: compute D1, D2
D1 = D0(1+g*) = 1(1+.2)= 1.2
D2 = D1(1+g*) = 1.2(1+1.2) = 1.44
Step 2: compute P2 = D3/(k-g)
D3 = D2(1+g) = 1.44(1+0.05)= 1.512
P2 = 1.512/(0.14-0.05) = 16.8
Step 3: Compute P0 by discounting D1, D2, and P2 to present
P0 =
1.2
1.44
16.8
+
+
= 15.1
1
2
(1 + 0.14)
(1 + 0.14)
(1 + 0.14) 2
3. Southwest Technology's common stock is selling at $30 per share today. Southwest just paid a $2 dividend. Its dividend is expected to grow by 5% in the coming year. The required rate of return on
Southwest is 15%. Determine the common stock's dividend yield and capital gain yield for the first year. a. 10%; 5%
b. 7%; 8%
c. 5%; 10%
d. 6.7%; 8.3%
3. b dividend yield = D1/P0
D1 = D0(1+g) = 2(1+0.05) = 2.1
So dividend yield = 2.1/30 = 0.07
We have total return = dividend yield + capital gain yield
15% = 7% + capital gain yield
So capital gain yield = 15% - 7% = 8%
4. Heavenly Hotels, Inc. will not pay any dividends for the next three years.
Fall 2009
Homework 8
Instructions: please read carefully
•
•
You should show your work how to get the answer for each calculation question to get full credit The due date is Tue Dec 15, 2009. Late homework will not be graded.
Name(s):
Student ID
1. A constant-growing stock just paid $2 dividend and has a current market price of $30. Determine the stock's required rate of return if the company's constant growth rate is 5%.
a. 5%
b. 7%
c. 12%
d. 14%
1. c
R = D1/Po + g = 2(1+0.05)/30 + 0.05 = 0.12
2. Stock analysts just predicted that Hybrid Engine Company's earnings and dividends will grow at 20% each year for the next two years due to its new invention. After that, its growth rate will stabilize at
5% per year indefinitely. Assume that the rate of return on the stock is 14% and its last dividend was
$1 per share. Determine the current price of the company's stock.
a. $16.8
b. $15.1
c. $16.1
d. $13.8
2. b
Step 1: compute D1, D2
D1 = D0(1+g*) = 1(1+.2)= 1.2
D2 = D1(1+g*) = 1.2(1+1.2) = 1.44
Step 2: compute P2 = D3/(k-g)
D3 = D2(1+g) = 1.44(1+0.05)= 1.512
P2 = 1.512/(0.14-0.05) = 16.8
Step 3: Compute P0 by discounting D1, D2, and P2 to present
P0 =
1.2
1.44
16.8
+
+
= 15.1
1
2
(1 + 0.14)
(1 + 0.14)
(1 + 0.14) 2
3. Southwest Technology's common stock is selling at $30 per share today. Southwest just paid a $2 dividend. Its dividend is expected to grow by 5% in the coming year. The required rate of return on
Southwest is 15%. Determine the common stock's dividend yield and capital gain yield for the first year. a. 10%; 5%
b. 7%; 8%
c. 5%; 10%
d. 6.7%; 8.3%
3. b dividend yield = D1/P0
D1 = D0(1+g) = 2(1+0.05) = 2.1
So dividend yield = 2.1/30 = 0.07
We have total return = dividend yield + capital gain yield
15% = 7% + capital gain yield
So capital gain yield = 15% - 7% = 8%
4. Heavenly Hotels, Inc. will not pay any dividends for the next three years.