CH 09

Fundamentals of Corporate Finance, 3rd edition
Solutions Manual
Chapter 9
Stock Valuation
Before You Go On Questions and Answers
Section 9.1
1. What is NASDAQ?
The National Association of Securities Automatic Quotation (NASDAQ) system is one of the
largest electronic stock markets in the world, listing over three thousand companies. It was
created in 1971 by the National Assoc. of Securities Dealers
2. How do dealers differ from brokers?

A dealer differs from a broker in that a dealer takes ownership of assets and is exposed to
inventory risk, while a broker only facilitates a transaction on behalf of a client. Unlike
brokers, dealers are subject to capital risk, because they must finance their inventories of
securities.
3. List the major stock market indexes, and explain what they tell us.
The major U.S. Stock market indexes are the Dow Jones Industrial Average, New York Stock
Exchange, Standard & Poors 500 Index, and NASDAQ Composite Index. A stock market
index is essentially a listing of stocks that bear some commonality, such as being traded on
the same market exchange. They are used to measure the stock market performance and
many are used to benchmark the performance of portfolios, such as mutual funds.
Copyright 2015 John Wiley & Sons, Inc.
SM 9-1
Solutions Manual
4. What does the price-earnings ratio tell us?

The price-earnings ratio is the firms current price divided by the current earnings. When
valuing a companys stock, it is useful to look at a companys ratio and compare it to that of
similar firms. In general, a high P/E ratio means high projected earnings in the future. In
addition, it also tells us how much investors are willing to pay per dollar of earnings.
5. Why do some people view preferred stock as a special type of a bond rather than a stock?
Just like debt, preferred stock is often callable and may be convertible into common stock.
Also, like debt, it has credit ratings that are similar to those issued to bonds. But most
important, preferred stock has no voting rights and just like bonds pays fixed dividends. For
these reasons, many analysts treat preferred stock as a special kind of debt rather than as an
equity.
Section 9.2
1
What is the general formula used to calculate the price of a share of a stock? What does it
mean?
The general formula developed to value a share of stock is as follows:
P0
D3
D5
D1
D2
D4

2
3
4
(1 R ) (1 R )
(1 R )
(1 R )
(1 R ) 5
It says that the price of a share of stock is the present value of all expected future dividends,
or: Stock price = PV (all future cash dividends).
2
What are growth stocks, and why do they typically pay little on dividends?
Growth stocks are defined as equity in any company whose earnings are growing faster than
the average firm and the higher growth rate is expected to continue for some time. Instead of
SM 9-2
Solutions Manual
paying dividends, these firms reinvest the earnings back into the firm to pursue other highreturn investment opportunities.
Section 9.3
1
What three different models are used to value stocks based on different dividend patterns?
Based on dividend patterns, we can use the following three models to value stock: (1) zerogrowth dividend model, (2) constant-growth dividend model, or (3) supernormal dividend
growth model.
2. Explain why the growth rate g must always be less than the rate of return R.
For the valuation equation to have any meaning, the firms dividend growth rate g must be
less than the rate of return R. It also makes intuitive sense, since no firm can in the long run
grow faster than the rate of economy. If that was the case, this one firm would become 100
percent of the economy and that makes no sense.
Section 9.4
1
Why can skipping payment of a preferred dividend be a bad signal?

A preferred dividend is treated like an interest payment on debt by financial markets and
investors. Although the firm will not be in default, any delay or failure to pay the dividends
by the firm will be treated seriously by the financial markets and make them think that the
firm is in financial difficulty.
How is a preferred stock with a fixed maturity valued?

Any preferred stock with a defined maturity date is similar to a bond with a fixed maturity
date. This similarity allows for the preferred stock to be valued in a similar fashion after
making adjustments for differences in the preferred stock relative to a bond. Using Equation
7.2, developed to value bonds, the coupons are replaced by the preferred dividends and the
SM 9-3
Solutions Manual
number of payments is adjusted to four a year to accommodate the fact that firms pay the
dividends every quarter and not semiannually. This results in the model represented by
Equation 8.7.
Self- Study Problems
9.1
Ted McKay has just bought the common stock of Ryland Corp. The company expects to
grow at the following rates for the next three years: 30 percent, 25 percent, and 15
percent. Last year the company paid a dividend of $2.50. Assume a required rate of return
of 10 percent. Compute the expected dividends for the next three years and also the
present value of these dividends.
Solution:
Expected dividends for Ryland Corp and their present value:
0
10%
D0 = $2.50
D1
g1 = 30%
D2
D3
g2 = 25%
D1 =
D0 (1 + g1) = $2.50(1 + 0.30) = $3.25
D2 =
D1 (1 + g2) = $3.25(1 + 0.25) = $4.06
D3 =
D2 (1 + g3) = $4.06(1 + 0.15) = $4.67
g3 = 15%
R = 10%
Present value of the dividends = PV(D1) + PV(D2) + PV(D3)

= $2.95 + $3.36 + $3.51
= $9.82
9.2
Merriweather Manufacturing Company has been growing at a rate of 6 percent for the
past two years, and the CEO expects the company to continue to grow at this rate for the
next several years. The company paid a dividend of $1.20 last year. If your required rate
SM 9-4
Solutions Manual
of return is 14 percent, what is the maximum price that you would be willing to pay for
this companys stock?
Solution:
Present value of Merriweather stock:
0
14%
D0 = $1.20
D1
D2
D3
g = 6%
R = 14%
D1 = D0 (1 + g)
= $1.20(1 + 0.06)
= $1.27
D1
$1.27
( R g) (0.14 0.06)
$15.88
P0
D1
$1.27
( R g ) (0.14 0.06)
$15.90
The maximum price you should be willing to pay for this
P0
stock is $15.90.
9.3
Clarion Corp. has been selling electrical supplies for the past 20 years. The companys
product line has changed very little in the past five years, and the companys management
does not expect to add any new items for the foreseeable future. Last year, the company
paid a dividend of $4.45 to its common stockholders. The company is not expected to
increase its dividends for the next several years. If your required rate of return for such
firms is 13 percent, what is the current value of this companys stock?
Solution:
Present value of Clarion Corp. stock:
SM 9-5
13%
Solutions Manual
Year
D0 = $4.45
D1
D2
D3
g = 0%
R = 13%
Since the companys dividends are not expected to grow,
D0 = D1 =D2=..D = $4.45 = D
Current value of the stock
9.4
D/R
$4.45/0.13
$34.23
Barrymore Infotech is a fast -growing communications company. The company did not
pay a dividend last year and is not expected to do so for the next two years. Last year the
companys growth accelerated, and management expects to grow the business at a rate of
35 percent for the next five years before growth slows to a more stable rate of 7 percent.
In the third year, management has forecasted a dividend payment of $1.10. Dividends
will grow with the company thereafter. Calculate the value of the companys stock at the
end of its rapid growth period (i.e., at the end of five years). The required rate of return
for such stocks is 17 percent. What is the current value of this stock?
Solution:
Present value of Barrymore Infotech stock:
0 17% 1
D0
D1
D2
g1 g5 = 35%
D3
D4
D5
D6
g6 and beyond = 7%
R = 17%
D0 = D1 =D2 = 0
D3 = $1.10
D4 = D3 (1 + g4) = $1.10(1 + 0.35) =$1.485
SM 9-6
Solutions Manual
D5 = D4 (1 + g5) = $1.485(1 + 0.35) = $2.005

D6 = D5 (1 + g6) = $2.005(1 + 0.07) = $2.145
Value of stock at t = 5 P5:
D6
$2.145
( R g ) (0.17 0.07)
$21.45
P5
Present value of the dividends in years 1 to 5 = PV(D1) + PV(D2) + PV(D3) + PV(D4) + PV(D5)
$1.10 $1.485 $2.005
(1.17)3 (1.17) 4 (1.17)5

$0 $0 $0.69 $0.79 $0.91
$0 $0
$2.39
Current value of stock = PV(Dividends) + PV(P5)

= $2.39 + [$21.45/(1.17)5]
= $2.39 + $9.78
= $ 12.18
9.5
You are interested in buying the preferred stock of a bank that pays a dividend of $1.80
every quarter. If you discount such cash flows at 8 percent, what is the value of this
stock?
Solution:
Present value of preferred bank stock:
Quarterly dividend on preferred stock = D = $1.80
Required rate of return = 8%
Current value of stock: =
Po
D
R
$1.80 4
0.08
$90.00
SM 9-7
Solutions Manual
Discussion Questions
9.1
Why can the market price of a stock differ from its true (intrinsic) value?
Let us start by first defining the market price of a stock as the price that equates the
demand for a stock with the supply of the stock. The role of the stock markets is to bring
buyers and sellers together in the most efficient way such that stocks are bought and sold
at the market price. In reality, however, barriers of various kinds including the geographic
separation of the two parties, strong demand that leads to overvaluation and vice versa,
make the market price of a security slightly different than its true (intrinsic) value. The
more efficient the market place, the smaller the deviation between the two.
LO: 1
Level: Basic
Bloomcode: Comprehension
AASCB: Analytic
IMA: Corporate Finance
AICPA: Measurement
9.2
Why are investors and managers concerned about stock market efficiency?
The role of secondary markets is to bring buyers and sellers together. Ideally, we would
like stock markets to be as efficient as possible. Markets are efficient when current
market prices of securities traded reflect all available information relevant to the security.
If this is the case, security prices will be near or at their true value. The more efficient the
market, the more likely this is to happen. This makes it easier for managers to price the
stocks close to their intrinsic value.
What investors are most concerned about is having complete information
regarding a stocks current price and where that price information can be obtained.
Efficient markets allow them to trade at prices that are closer to the true value than
otherwise possible.
SM 9-8
Solutions Manual
Thus, both investors who provide funds and managers (firms) who raise money
are concerned when high transaction costs lead to inefficient markets.
LO: 1
Level: Basic
AASCB: Analytic
AICPA: Measurement
9.3
Why are common stockholders considered to be more at risk than the holders of
other types of securities?
In the hierarchy of lenders of funds to a firm, common stockholders have the most to
lose. In the event of a firm becoming bankrupt, the law requires that creditors of different
types, including bondholders, be paid off first. Next, preferred stockholders are paid off.
Finally, common stockholders receive their investment if any funds are still available.
Thus, common stockholders receive their money back last and are placed at most risk.
This feature of common equity is referred to as residual claim.
LO: 1
Level: Basic
AASCB: Analytic
AICPA: Measurement
9.4
Under what conditions does it make sense to use the constant-growth dividend
model to value a stock?
It only makes sense to use the constant-growth dividend model to value the stock of a
company that is already paying a dividend and when that dividend can reasonably be
expected to grow at a constant rate forever
in other words, the stock of a mature
company. As discussed in the chapter, the growth rate of such a company will be less than
the long term rate of inflation and the real growth rate of the economy. It must also be
less than the required rate of return on the stock.
LO: 4
SM 9-9
Solutions Manual
Level: Basic
AASCB: Analytic
AICPA: Measurement
9.5
What does it mean when a company has a very high P/E ratio? Give examples of
industries in which you believe high P/E ratios are justified.
A high P/E ratio implies that investors believe that the firm has good prospects for
earnings growth in the future. In fact, they believe that the firm will have higher growth
potential than firms with lower P/E ratios. Companies in industries that are fast growing
like biotech or any hi-tech industry have high P/E ratios. In the past, firms like Cisco and
Intel had very high P/E ratios. As these firms matured and settled to annual growth rates
of 15 percent or less, their P/E ratios have declined.
LO: 1
Level: Basic
AASCB: Analytic
AICPA: Measurement
9.6
Explain why preferred stock is considered to be a hybrid of equity and debt

securities.
The law considers preferred stock as equity. Thus, holders are treated as the firms
owners. Also, like common stockholders, preferred stockholders have to pay taxes on
their dividend income. However, preferred stockholders do not have any voting rights. In
addition, they receive only a fixed dividend just like bondholders. If a firm is liquidated,
then they receive a stated value (par value) similar to bondholders. Preferred stock is
rated by credit rating agencies just like bonds. Some preferred issues are convertible to
the firms common stock just as convertible bonds. Some preferred issues are not
perpetual and have a fixed maturity just like bonds.
Thus preferred stock is a hybrid securitylike equity in some ways and like debt
security in others.
SM 9-10
Solutions Manual
LO: 2
Level: Basic
AASCB: Analytic
AICPA: Measurement
9.7
Why is stock valuation more difficult than bond valuation?

Despite the availability of mathematical models to value stocks, it is more difficult to
apply valuation techniques to stocks than to bonds. First, unlike bonds, firms are not in
default if dividends are not declared. This makes it difficult to determine the size and
timing of the cash flows. Second, common stock, unlike bonds, does not have a fixed
maturity, and hence, it is difficult to determine a terminal value unlike bonds, which have
a maturity value. Next, it is easier to calculate the present value of a bond because the
required rate of return is observable. In the case of stocks, it is rather difficult to estimate
a required rate of return for many stocks and classify them into different risk groups.
LO: 2
Level: Intermediate
AASCB: Analytic
AICPA: Measurement
9.8
You are currently thinking about investing in a stock valued at $25.00 per share.
The stock recently paid a dividend of $2.25 and its dividend is expected to grow at a
rate of 5 percent for the foreseeable future. You normally require a return of 14
percent on stocks of similar risk. Is the stock overpriced, underpriced, or correctly
priced?
D0 = $2.25
Required rate of return (R) = 14%
Growth rate (g) = 5%
Using Constant-growth model, the price of stock is:
SM 9-11
P0
Solutions Manual
D (1 g )
D1
0
Rg
Rg
$2.25(1.05)
$26.25
0.14 0.05
This stock is underpriced at $25. Using the constant-growth model, we arrived at a price
of $26.25 for this stock. This makes the stock underpriced, and it should be considered a
good buy.
LO: 4
Level: Basic
Bloomcode: Analysis
AASCB: Analytic
AICPA: Measurement
9.9
Stock A and Stock B are both priced at $50 per share. Stock A has a P/E ratio of 17,
while Stock B has a P/E ratio of 24. Which is the more attractive investment,
considering everything else to be the same, and why?
Stock A is the more attractive investment because it has a lower P/E ratio. The lower the
P/E ratio, the larger the amount of earnings supporting the stock price. This makes Stock
A a more attractive investment than Stock B.
LO: 1
Level: Basic
Bloomcode: Analysis
AASCB: Analytic
AICPA: Measurement
9.10
Facebook does not pay dividends. How can it have a positive stock price?
Investors expect that Facebook will eventually start paying dividends and the value of its
shares reflects the present value of these expected dividends. The fact that a company is
not currently paying dividends does not mean that its stock is worthless. It is not
uncommon for high growth firms not to pay dividends, since they often have to reinvest
all of their earnings to maintain their high growth rate. However, if they are successful, as
SM 9-12
Solutions Manual
their growth rate slows over time they will begin to pay dividends. Examples of such
companies that do not pay dividends include Apple, Microsoft, Dell, among many others.
LO: 3, 4
Level: Intermediate
AASCB: Analytic
AICPA: Measurement
Questions and Problems
BASIC
9.1
Stock Market Index: What is a stock market index?
Solution:
A stock market index is used to measure the performance of the stock market. These
indexes reflect the value of the stocks in a particular market, such as the NYSE or the
NASDAQ, or across markets, and increase and decrease as the values of the stocks go up
and down. Examples of stock market indexes include the Dow Jones Industrial Average,
the New York Stock Exchange Index, the Standard & Poors 500 Index, and the
NASDAQ Composite Index.
LO 1
Bloomcode: Knowledge
AASCB: Analytic
AICPA: Measurement
9.2
Stock Market Index: What is the Dow Jones Industrial Average?
Solution:
SM 9-13
Solutions Manual
The Dow is the most widely published stock index and reflects the value of the stocks of
30 large companies. The value of the shares of these companies represents about 20
percent of the market value of all U.S. stocks.
LO 1
AASCB: Analytic
AICPA: Industry/Sector Perspective
9.3
Stock Market Index: What does NASDAQ stand for? What is NASDAQ?
Solution:
NASDAQ stands for National Association of Securities Dealers Automated Quotation
system. NASDAQ is one of the largest electronic stock markets in the world, listing over
three thousand companies. It is an OTC market and does not have any physical location.
Companies listed on NASDAQ had market capitalization of $6.2 trillion as of December
2013.
LO 1
AASCB: Analytic
9.4
Dividend yield: What is a dividend yield? What does it tell us?
Solution:
A dividend yield is the ratio of the annual dividend payout by the current market price of
a stock. It tells us what percentage return we would earn from dividends alone if we
purchased the stock at its current price. Alternatively, it tells us what percentage of the
firms stock value is being distributed to stockholders each year.
LO 1
AASCB: Analytic
AICPA: Measurement
SM 9-14
9.5
Solutions Manual
Present value of dividends: Fresno Corp. is a fast-growing company whose

management expects it to grow at a rate of 30 percent over the next two years and then
slow down to a growth rate of 18 percent for the following three years. If the last
dividend paid by the company was $2.15, estimate the dividends for the next five years.
Compute the present value of these dividends if the required rate of return is 14 percent.
Solution:
0
D0 = $2.15
g1-2 = 30%;
g3-5 = 18%;
R = 14%
D1 = D0 (1 + g1) = $2.15(1.30) = $2.795

D2 = D1 (1 + g2) = $2.795(1.30) = $3.634
D3 = D2 (1 + g3) = $3.634(1.18) = $4.288
D4 = D3 (1 + g4) = $4.288(1.18) = $5.06
D5 = D4 (1 + g5) = $5.06(1.18) = $5.97
$2.795 $3.634 $4.288 $5.06
$5.97
1
2
3
4
(1.14) (1.14)
(1.14)
(1.14)
(1.14)5
$2.45 $2.80 $2.89 $3.00 $3.10
PV( Dividends )
$14.24
LO 4
Bloomcode: Application
AASCB: Analytic
AICPA: Measurement
9.6
Zero growth: Nynet, Inc., paid a dividend of $4.18 last year. The companys
management does not expect to increase its dividend in the foreseeable future. If the
required rate of return is 18.5 percent, what is the current value of the stock?
Solution:
D0 = $4.18; g = 0;
R = 18.5%
SM 9-15
P0
Solutions Manual
D $4.18
$22.59
R 0.185
LO 4
AASCB: Analytic
AICPA: Measurement
P0
D $4.18
$22.59
R 0.185
9.7
Zero growth: Knight Supply Corp. has not grown for the past several years and
management expects this lack of growth to continue. The firm last paid a dividend of
$3.56. If you require a rate of return of 13 percent, what is the current value of this stock
to you?
Solution:
D0 = $3.56; g = 0;
P0
R = 13%
D $3.56
$27.38
R 0.13
LO 4
AASCB: Analytic
AICPA: Measurement
9.8
P0
D $3.56
$27.38
R 0.13
Zero growth: Ron Santana is interested in buying the stock of First National Bank.
While the banks management expects no growth in the near future, Ron is attracted by
the dividend income. Last year the bank paid a dividend of $5.65. If Ron requires a return
of 14 percent on such stocks, what is the maximum price he should be willing to pay for a
share of the banks stock?
Solution:
D0 = $5.65; g = 0;
R = 14%
SM 9-16
P0
Solutions Manual
D $5.65
$40.36
R 0.14
LO 4
AASCB: Analytic
AICPA: Measurement
9.9
Zero growth: The current stock price of Largent, Inc., is $44.72. If the required rate of
return is 19 percent, what is the dividend paid by this firm if the dividend is not expected
to grow in the future?
Solution:
P0 = $44.72;
P0
R = 19%;
D = ?;
D
R
D
0.19
D $44.72 0.19 $8.50
$44.72
LO 4
AASCB: Analytic
AICPA: Measurement
9.10
Constant growth: Moriband Corp. paid a dividend of $2.15 yesterday. The companys
dividend is expected to grow at a steady rate of 5 percent for the foreseeable future. If investors
in stocks of companies like Moriband require a rate of return of 15 percent, what should be the
market price of Moriband stock?
Solution:
D0 = $2.15;
g = 5%;
R = 15%
SM 9-17
P0
Solutions Manual
D1
D (1 g )
0
Rg
Rg
$2.15(1.05)
$22.58
0.15 0.05
LO 4
AASCB: Analytic
AICPA: Measurement
9.11
Constant growth: Nyeil, Inc., is a consumer products firm that is growing at a constant
rate of 6.5 percent. The firms last dividend was $3.36. If the required rate of return is 18
percent, what is the market value of this stock if dividends grow at the same rate as the
firm?
Solution:
D0 = $3.36;
P0
g = 6.5%;
R = 18%
D1
$3.36(1.065)
R g 0.18 0.065
$31.12
LO 4
AASCB: Analytic
AICPA: Measurement
9.12
Constant growth: Reco Corp. is expected to pay a dividend of $2.25 next year. The
forecast for the stock price a year from now is $37.50. If the required rate of return is 14
percent, what is the current stock price? Assume constant growth.
Solution:
D1 = $2.25;
P1 = $37.50;
R = 14%
SM 9-18
P1
$37.50
Solutions Manual
D2
D (1 g )
1
Rg
Rg
$2.25(1 g )
0.14 g
$37.50(0.14 g ) $2.25 2.25 g

$5.25 37.5 g 2.25 2.25 g
$5.25 $2.25 37.5 g 2.25 g
g
$3.00
7.55%
$39.75
P0
D1
Rg
$2.25
$34.87
0.14 0.0755
LO 4
AASCB: Analytic
AICPA: Measurement
P1
$37.50
D2
D (1 g )
1
Rg
Rg
$2.25(1 g )
0.14 g
$37.50(0.14 g ) $2.25 2.25 g

$5.25 37.5 g 2.25 2.25 g
$5.25 $2.25 37.5 g 2.25 g
g
$3.00
7.55%
$39.75
P0
D1
Rg
$2.25
$34.87
0.14 0.0755
SM 9-19
9.13
Solutions Manual
Constant growth: Proxicam, Inc., is expected to grow at a constant rate of 7 percent. If

the companys next dividend, which will be paid in a year, is $1.15 and its current stock
price is $22.35, what is the required rate of return on this stock?
Solution:
D1 = $1.15;
P0
D1
Rg
D1
g
P0
P0 = $22.35;
g = 7%
$1.15
0.07
$22.35
0.0515 0.07 12.15%

LO 4
AASCB: Analytic
AICPA: Measurement
9.14
Preferred stock valuation: X-Centric Energy Company has issued perpetual preferred
stock with a stated (par) value of $100 and a dividend of 4.5 percent. If the required rate
of return is 8.25 percent, what is the stocks current market price?
Solution:
D = 4.5% ($100) = $4.50;
P0
R = 8.25%
D $4.50
$54.55
R 0.0825
LO 6
AASCB: Analytic
AICPA: Measurement
SM 9-20
9.15
Solutions Manual
Preferred stock valuation: The First Bank of Flagstaff has issued perpetual preferred
stock with a $100 par value. The bank pays a quarterly dividend of $1.65 on this stock.
What is the current price of this preferred stock given a required rate of return of 11.6
percent?
Solution:
Quarterly dividend = $1.65
Required rate of return = R = 11.6%
P0
(1.65 4)
$56.90
0.116
LO 6
AASCB: Analytic
AICPA: Measurement
9.16
Preferred stock valuation: The preferred stock of Axim Corp. is currently selling at
$47.13. If the required rate of return is 12.2 percent, what is the dividend paid by this
stock?
Solution:
P0 = $47.13;
R = 12.2%
D
0.122
D $47.13 0.122
$5.75
P0 $47.13
LO 6
AASCB: Analytic
AICPA: Measurement
SM 9-21
9.17
Solutions Manual
Preferred stock valuation: Each quarter, Sirkota, Inc., pays a dividend on its perpetual
preferred stock. Today the stock is selling at $63.37. If the required rate of return for such
stocks is 15.5 percent, what is the quarterly dividend paid by Sirkota?
Solution:
P0 = $63.37;
R = 15.5%
D
0.155
D $63.37 0.155
$9.82
P0 $63.37
Annual dividend = $9.82

Quarterly dividend = $9.82 /4 = $2.46
LO 6
AASCB: Analytic
AICPA: Measurement
INTERMEDIATE
9.18
Constant growth: Kay Williams is interested in purchasing the common stock of

Reckers, Inc., which is currently priced at $37.45. The company is expected to pay a
dividend of $2.58 next year and to increase its dividend at a constant rate of 7 percent.
a. What should the market value of the stock be if the required rate of return is 14
percent?
b. Is this a good buy? Why or why not?
Solution:
a.
b.
P0
D1
$2.58
$36.86
R g 0.14 0.07
The stock is overpriced and not a good buy.
SM 9-22
Solutions Manual
LO 4
Bloomcode: Analysis
AASCB: Analytic
AICPA: Measurement
9.19
Constant growth: The required rate of return is 23 percent. Ninex Corp. has just paid a
dividend of $3.12 and is expected to increase its dividend at a constant rate of 5 percent.
What is the expected price of the stock three years from now?
Solution:
R = 23%;
P3
D0 = $3.12;
g = 5%
D4
D (1 g ) 4
0
Rg
Rg
3.12(1.05) 4
$21.07
0.23 0.05
LO 4
AASCB: Analytic
AICPA: Measurement
9.20
Constant growth: Jenny Banks is interested in buying the stock of Fervan, Inc., which is
increasing its dividends at a constant rate of 6 percent. Last year the firm paid a dividend
of $2.65. The required rate of return is 16 percent. What is the current value of this stock?
What should be the price of the stock in year 5?
Solution:
g = 6%,
D0 = $2.65,
R = 16%
P0
D1
$2.65(1.06)
$28.09
R g 0.16 0.06
P5
D6
$2.65(1.06) 6
$37.59
Rg
0.16 0.06
SM 9-23
Solutions Manual
LO 4
AASCB: Analytic
AICPA: Measurement
9.21
Constant growth: You own shares of Old World DVD Company and are interested in
selling them. With so many people downloading music these days, sales, profits, and
dividends at Old World have been declining 6 percent per year. The firm just paid a
dividend of $1.15 per share. The required rate of return for a stock this risky is 15
percent. If dividends are expected to decline at 6 percent per year, what is a share of the
stock worth today?
Solution:
R = 15%;
P0
D0 = $1.15;
g = -6%
D1
D (1 g )
0
Rg
Rg
$1.15 (1 0.06)
$5.15
0.15 ( 0.06)
LO 4
AASCB: Analytic
AICPA: Measurement
9.22
Nonconstant growth: You own a company that competes with Old World DVD
Company (in the previous problem). Instead of selling DVDs, however, your company
sells music downloads from a web site. Things are going well now, but you know that it
is only a matter of time before someone comes up with a better way to distribute music.
Your company just paid a $1.50 per share dividend, and you expect to increase the
dividend 10 percent next year. However, you then expect your dividend growth rate to
begin going down to 5 percent the following year, 2 percent the next year, and to -3
percent per year thereafter. Based upon these estimates, what is the value of a share of
your companys stock? Assume that the required rate of return is 12 percent.
SM 9-24
Solutions Manual
Solution:
g1 = 10%, g2 = 5%,
g3 =2%,
D1 = $1.50 1.1 = $1.65,

$1.7672,
g = -3%,
D0 = $1.50 R = 12%
D2 = $1.65 1.05 = $1.7325, D3 = $1.7325 1.02 =
D4 = $1.7672 0.97 = $1.7141.
P3
D4
$1.7141
$11.43
R g 0.12 (0.03)
P0
D1
D2
D3
P3
2
3
1 R (1 R) (1 R) (1 R) 3
P0
$1.65 $1.7325 $1.7672 $11.43
1.12
(1.12) 2
(1.12)3 (1.12)3
P0 $1.47 $1.38 $1.26 $8.14

P0 $12.25
LO 5
AASCB: Analytic
AICPA: Measurement
9.23
Nonconstant growth: Tre-Bien, Inc., is a fast-growing technology company.

Management projects rapid growth of 30 percent for the next two years, then a growth
rate of 17 percent for the following two years. After that, a constant-growth rate of 8
percent is expected. The firm expects to pay its first dividend of $2.45 a year from now. If
dividends will grow at the same rate as the firm and the required rate of return on stocks
with similar risk is 22 percent, what is the current price of the stock?
Solution:
g1 = g2 = 30%,
D1 = $2.45,
g3 = g4 = 17%,
D2 = $2.45 1.30 = $3.19,
D4 = $3.73 1.17 = $4.36,
P4
g = 8%,
D1 = $2.45,
R = 22%
D3 = $3.19 1.17 = $3.73
D5 = 4.36 1.08 = $4.71
D5
$4.71
$33.63
R g 0.22 0.08
SM 9-25
P4
D5
$4.71
$33.63
R g 0.22 0.08
P0
D1
D2
D3
D4
P4
2
3
4
1 R (1 R) (1 R) (1 R) (1 R) 4
P0
$2.45 $3.19
$3.73 ($4.36 33.64)
2
1.22 (1.22) (1.22) 3
(1.22) 4
Solutions Manual
P0 $2.01 $2.14 $2.05 17.15

P0 $23.35
LO 5
AASCB: Analytic
AICPA: Measurement
9.24
Nonconstant growth: Management of ProCor, a biotech firm, forecasted the following

growth rates for the next three years: 35 percent, 28 percent, and 22 percent. Management
then expects the company to grow at a constant rate of 9 percent forever. The company
paid a dividend of $1.75 last week. If the required rate of return is 20 percent, what is the
value of this stock?
Solution:
g1 = 35%; g2 = 28%; g3 = 22%; g4 = 9%; D0 = $1.75; R = 20%
SM 9-26
Solutions Manual
D1 D 0 (1 g 1 ) $1.75 1.35 $2.36

D2 D1 (1 g 2 ) $2.36 1.28 $3.02
D3 D 2 (1 g 3 ) $3.02 1.22 $3.69
D4 D3 (1 g ) $3.69 1.09 $4.02
P3
D4
$4.02
$36.57
R g 0.20 0.09
P0
D1
D2
D3
P3
2
3
1 R (1 R) (1 R) (1 R) 3
P0
$2.36 $3.02
$3.69 $36.57
2
1.20 (1.20) (1.20)3 (1.20) 3
P0 $1.97 $2.10 $2.14 $21.16

P0 $27.37
LO 5
AASCB: Analytic
AICPA: Measurement
SM 9-27
Solutions Manual
D1 D0 (1 g 1 ) $1.75 1.35 $2.36

D 2 D1 (1 g 2 ) $2.36 1.28 $3.02
D3 D 2 (1 g3 ) $3.02 1.22 $3.69
D 4 D3 (1 g ) $3.69 1.09 $4.02
P3
D4
$4.02
$36.56
R g 0.20 0.09
P0
D3
P3
D1
D2
2
3
1 R (1 R) (1 R) (1 R) 3
P0
$2.36 $3.02
$3.69 $36.56
2
1.20 (1.20) (1.20)3 (1.20)3
P0 $1.97 $2.10 $2.14 $21.16

P0 $27.36
9.25
Nonconstant growth: Revarop, Inc., is a fast- growth company that is expected to grow
at a rate of 23 percent for the next four years. It is then expected to grow at a constant rate
of 6 percent. Revarops first dividend, of $4.25, will be paid in year 3. If the required rate
of return is 17 percent, what is the current value of the stock if dividends are expected to
grow at the same rate as the company?
Solution:
g1-4 = 23%;
g = 6%;
D3 = $4.25;
R = 17%
D4 = D3 1.23 = $4.25 1.23 = $5.23
SM 9-28
P4
D5
$5.23 (1.06)
$50.37
Rg
0.17 0.06
P0
D3
D1
D2
D P4
4
2
3
1 R (1 R) (1 R) (1 R) 4
P0 0 0
Solutions Manual
$4.25 ($5.23 $50.37)
(1.17)3
(1.17) 4
P0 $2.65 $29.69 $32.33
LO 5
AASCB: Analytic
AICPA: Measurement
P4
D5
$5.23 (1.06)
$50.37
Rg
0.17 0.06
P0
D3
D1
D2
D P4
4
2
3
1 R (1 R) (1 R) (1 R) 4
P0 0 0
$4.25 ($5.23 $50.37)
(1.17)3
(1.17) 4
P0 $2.65 $29.67 $32.33
9.26
Nonconstant growth: Quansi, Inc., management expects to pay no dividends for the next
six years. It has projected a growth rate of 25 percent for the next seven years. After
seven years, the firm will grow at a constant rate of 5 percent. Its first dividend, to be
paid in year 7, will be $3.25. If the required rate of return is 24 percent, what is the stock
worth today?
Solution:
g = 5%; R = 24%; D7 = $3.25; D1 D6 = 0
SM 9-29
Solutions Manual
P7
D8
$3.25 (1.05)
$17.96
Rg
0.24 0.05
P0
D7 P7 $3.25 $17.96
$4.71
(1 R) 7
(1.24)7
LO 5
AASCB: Analytic
AICPA: Measurement
9.27
Nonconstant growth: Staggert Corp. will pay dividends of $5.00, $6.25, $4.75, and
$3.00 in the next four years. Thereafter, management expects the dividend growth rate to
be constant at 6 percent. If the required rate of return is 18.5 percent, what is the current
value of the stock?
Solution:
D1 = $5;
D2 = $6.25; D3 = 4.75;
D4 = $3; g = 6%; R = 18.5%;
P0
D1
D2
D3
D4
P4
2
3
4
1 R (1 R) (1 R) (1 R) (1 R) 4
P4
D5
$3 (1.06)
$25.44
R g 0.185 0.06
P0
$5
$6.25
$4.75
($3 $25.44)
2
3
1.185 (1.185) (1.185)
(1.185) 4
P0 $4.22 $4.45 $2.86 $14.42 $25.95
LO 5
AASCB: Analytic
AICPA: Measurement
SM 9-30
9.28
Solutions Manual
Nonconstant growth: Diaz Corp. is expected to grow rapidly at a rate of 35 percent for
the next seven years. The companys first dividend, to be paid three years from now, will
be $5. After seven years, the company (and the dividends it pays) will grow at a rate of
8.5 percent. What is the value of Diaz stock with a required rate of return of 14 percent?
Solution:
g1-7 = 35%; D3 = $5.00; g = 8.5%; R = 14%
D1 = D2 = 0;
D3 = $5
D4 = $5 1.35 = $6.75
D5 = $6.75 1.35 = $9.11
D6 =$9.11 1.35 = $12.30
D7 = $12.30 1.35 = $16.61
D8 = $16.61 1.085 = $18.02
P7
D8
$18.02
$327.64
R g 0.14 0.085
P0
D1
D2
D3
D4
D5
D6
D P7
7
2
3
4
5
6
1 R (1 R) (1 R) (1 R) (1 R) (1 R) (1 R) 7
00
$5
$6.75
$9.11 $12.30 ($16.61 $327.64)
3
4
(1.14) (1.14) (1.14)5 (1.14) 6
(1.14) 7
$3.38 $4.00 $4.73 $5.60 $137.58

$155.29
LO 5
AASCB: Analytic
AICPA: Measurement
9.29
Nonconstant growth: Tin-Tin Waste Management, Inc., is growing rapidly. Dividends

are expected to grow at rates of 30 percent, 35 percent, 25 percent, and 18 percent over
the next four years. Thereafter, management expects dividends to grow at a constant rate
of 7 percent. The stock is currently selling at $47.85, and the required rate of return is 16
percent. Compute the dividend for the current year (D0).
SM 9-31
Solutions Manual
Solution:
g1 = 30%; g2 = 35%; g3 = 25%; g4 = 18%; g = 7%; R = 16%; P0 = $47.85
P0
$47.85
D1
D2
D3
D4
P4
2
3
4
(1 R1 ) (1 R2 ) (1 R3 ) (1 R4 ) (1 R4 ) 4
D0 (1.30) D0 (1.30) (1.35) D 0 (1.30) (1.35) (1.25)
1.16
(1.16) 2
(1.16) 3
D (1.30) (1.35) (1.25) (1.18)

0
(1.16) 4
D0 (2.5886) (1.07)
0.16 0.07
(1.16) 4
D0 [1.12 1.30 1.41 1.43 17.00]

D0
$47.85
$2.15
$22.26
LO 5
AASCB: Analytic
AICPA: Measurement
ADVANCED
9.30
Equation 9.4 shows the relation between a stocks value and the dividend that is expected
next year if dividends grow at a constant rate forever. If a firm pays all of its earnings as
dividends, show how Equation 9.4 can be rearranged to calculate that firms P/E ratio.
What does this tell us about the factors that determine a firms P/E ratio?
Solution:
P0
D1
E1
R g R g , where, E1 is the earnings per share next year.
Rearranging the formula:
P0
1
E1 R g
SM 9-32
Solutions Manual
This formula tells us that the P/E ratio is determined by both the risk of the dividend cash
flows and the rate at which they are expected to grow.
LO 4
Bloomcode: Analysis
AASCB: Analytic
AICPA: Measurement
9.31
Riker Departmental Stores management has forecasted a growth rate of 40 percent for the
next two years, followed by growth rates of 25 percent and 20 percent for the following
two years. It then expects growth to stabilize at a constant rate of 7.5 percent forever. The
firm paid a dividend of $3.50 recently. If the required rate of return is 18 percent, what is
the current value of Rikers stock?
Solution:
g1-2 = 40%; g3 = 25%; g4 = 20%; g = 7.5%; D0 = $3.50; R = 18%
D1 D0 (1 g 1 ) $3.50 1.40 $4.90
D2 D1 (1 g 2 ) $4.90 1.40 $6.86
D3 D2 (1 g 3 ) $6.86 1.25 $8.575
D4 D3 (1 g 4 ) $8.575 1.20 $10.29
D5 D 4 (1 g) $10.29 1.075 $11.06
P4
D5
$11.06
$105.35
R g 0.18 0.075
P0
D1
D2
D3
D4
P4
2
3
4
1 R (1 R) (1 R) (1 R) (1 R) 4
P0
$4.90 $6.86 $8.575 $10.29 $105.35
1.18 (1.18) 2 (1.18)3 (1.18)4 (1.18)4
P0 $4.15 $4.93 $5.22 $5.31 $54.34

P0 $73.94
LO 5
SM 9-33
Solutions Manual
AASCB: Analytic
AICPA: Measurement
9.32
Courtesy Bancorp issued perpetual preferred stock a few years ago. The bank pays an
annual dividend of $4.27 and your required rate of return is 12.2 percent.
a.
What is the value of the stock given your required rate of return?
b.
Should you buy this stock if its current market price is $34.41? Explain.
Solution:
a.
D = $4.27; R = 12.2%
P0
b.
D $4.27
$35.00
R 0.122
Since the stock is worth $35.00 but can be purchased for $34.41, you should buy
this stock.
LO 4
Bloomcode: Analysis
AASCB: Analytic
AICPA: Measurement
9.33
Rhea Kirby owns shares in Ryoko Corp. Currently, the market price of the stock is
$36.34. Management expects dividends to grow at a constant rate of 6 percent for the
foreseeable future. Its last dividend was $3.25. Rheas required rate of return for such
stocks is 16 percent. She wants to find out whether she should sell her shares or add to
her holdings.
a.
What is the value of this stock?
b.
Based on your answer to part a, should Rhea buy additional shares in Ryoko
Corp? Why or why not?
Solution:
SM 9-34
a.
b.
P0
Solutions Manual
D1
$3.25 (1.06)
$34.45
Rg
0.16 0.06
No, she should not buy more shares. This stock is overpriced with the stock
selling at a higher price than what it is worth. She should sell her shares.
LO 4
Bloomcode: Analysis
AASCB: Analytic
AICPA: Measurement
9.34
Perry, Inc., paid a dividend of $2.50 yesterday. You are interested in investing in this
company, which has forecasted a constant-growth rate of 7 percent for its dividends,
forever. The required rate of return is 18 percent.
a.
Compute the expected dividends D1, D2, D3, and D4.
b.
Compute the present value of these four dividends.
c.
What is the expected value of the stock four years from now (P4)?
d.
What is the value of the stock today based on the answers to parts b and c?
e.
Use the equation for constant growth (Equation 9.4) to compute the value of the
stock today.
Solution:
a.
D0 = $2.50 g = 7%
R = 18%
D1 $2.50 (1.07) $2.675

D 2 $2.50 (1.07) 2 $2.86
D3 $2.50 (1.07) 3 $3.063
D 4 $2.50 (1.07) 4 $3.277
$2.675 $2.86 $3.063 $3.277
(1.18)1 (1.18) 2 (1.18)3 (1.18) 4

$2.27 2.05 $1.86 $1.69
PV ( Dividends )
b.
$7.88
SM 9-35
Solutions Manual
D5 D 4 (1 g ) $3.277 (1.07) $3.506
c.
D5
$3.506
$31.88
R g 0.18 0.07
P4
$31.88
$16.44
(1.18)4
P0 PV ( Dividends ) PV ( P4 )
PV ( P4 )
$7.87 $16.44
$24.32
d.
e.
For a constant-growth stock:

P0
D1
$2.675
$24.32
R g 0.18 0.07
LO 4
AASCB: Analytic
AICPA: Measurement
9.35
Zweite Pharma is a fast -growing drug company. Management forecasts that in the next
three years, the companys dividend growth rates will be 30 percent, 28 percent, and 24
percent, respectively. Last week it paid a dividend of $1.67. After three years,
management expects dividend growth to stabilize at a rate of 8 percent. The required rate
of return is 14 percent.
a.
Compute the dividends for each of the next three years, and calculate their present
value.
b.
Calculate the price of the stock at the end of year 3, when the firm settles to a
constant-growth rate.
c.
What is the current price of the stock?
SM 9-36
Solutions Manual
Solution:
g1 = 30%; g2 = 28%; g3 = 24%; g = 8%; D0 = $1.67; R = 14%
D1 D 0 (1 g 1 ) $1.67 (1.30) $2.171
D 2 D1 (1 g 2 ) $2.171 (1.28) $2.779
D3 D 2 (1 g 3 ) $2.779 (1.24) $3.446
PV(Dividends)
D1
D2
D3
2
1 R (1 R)
(1 R)3
$2.171 $2.779 $3.446
1.14
(1.14) 2 (1.14)3
$1.90 $2.14 $2.33 $6.37
a.
b.
D 4 D3 (1 g ) $3.446 (1.08) $3.722

D4
$3.722
$62.02
R g 0.14 0.08
P3
$62.03
$41.87
(1.14)3
P0 PV ( Dividends ) PV ( P3 )
PV ( P3 )
c.
$6.37 $41.87
$48.23
LO 5
AASCB: Analytic
AICPA: Measurement
SM 9-37
9.36
Solutions Manual
Triton Inc., is expected to grow at a rate of 22 percent for the next five years and then
settle to a constant growth rate of 6 percent. The company recently paid a dividend of
$2.35. The required rate of return is 15 percent.
a.
Find the present value of the dividends during the rapid-growth period if
dividends grow at the same rate as the company.
b.
What is the value of the stock at the end of year 5?
c.
What is the value of the stock today?
Solution:
g1-5 = 22%; g = 6%; D0 = $2.35; R = 15%
a.
D1 D0 (1 g 1 ) $2.35 (1.22) $2.867
D 2 D1 (1 g 2 ) $2.867 (1.22) $3.498
D3 D 2 (1 g3 ) $3.498 (1.22) $4.267
D 4 D3 (1 g 4 ) $4.267 (1.22) $5.206
D5 D4 (1 g ) $5.206 (1.22) $6.351
PV(Dividends)
D3
D5
D1
D2
D4
2
3
4
1 R (1 R) (1 R) (1 R) (1 R)5
$2.867 $3.498 $4.267 $5.206 $6.351
1.15
(1.15) 2 (1.15)3 (1.15) 4 (1.15)5
$2.49 $2.65 $2.81 $2.98 $3.16

$14.09
D6 D5 (1 g ) $6.351 (1.06) $6.732
b.
P5
D6
$6.732
$74.80
R g 0.15 0.06
SM 9-38
PV(P5 )
Solutions Manual
$74.80
$37.19
(1.15)5
P0 PV(Dividends) PV(P5 )
$14.09 $37.19
$51.28
c.
LO 5
AASCB: Analytic
AICPA: Measurement
9.37
Ceebros Builders is expanding very fast and is expected to grow at a rate of 25 percent
for the next four years. The company recently paid a dividend of $3.60 but is not
expected to pay any dividends for the next three years. In year 4, management expects to
pay a $5 dividend and thereafter to increase the dividend at a constant rate of 6 percent.
The required rate of return on such stocks is 20 percent.
a.
Calculate the present value of the dividends during the fast-growth period.
b.
What is the value of the stock at the end of the fast-growth period (P4)?
c.
What is the value of the stock today?
d.
Would todays stock value be affected by the length of time you intend to hold the
stock?
Solution:
a.
g1-4 = 25% g = 6% D0 = $3.60 D4 = $5.00 R = 20%

PV( Dividends ) 0 0 0
b.
c.
P4
$5
$2.41
(1.20) 4
D5
$5.00 (1.06)
$37.86
Rg
0.20 0.06
P0 $2.41
$37.86
$20.67
(1.20) 4
SM 9-39
d.
Solutions Manual
No, the length of the holding period has no bearing on todays stock price.
LO 5
AASCB: Analytic
AICPA: Measurement
Sample Test Problems
9.1
Which type of secondary market provides the most efficient market for financial
securities? (LO 1)
Solution:
An auction market is the most efficient type of secondary market because the buyers and
sellers in an auction market interact directly with each other and bargain over price.
AASCB: Analytic
9.2
Is preferred stock a debt or an equity security? (LO 2)

Solution:
Preferred stock represents an ownership interest in a corporation and is legally a form of
equity. However, it does have characteristics that are similar to those of debt, such as no
voting rights, fixed payments (dividends), and credit ratings similar to those issued to
bonds.
AASCB: Analytic
AICPA: Measurement
9.3
Burnes, Inc. is a mature firm that is growing at a constant rate of 5.5 percent per year. The
last dividend that the firm paid was $1.50 per share. If dividends are expected to grow at
the same rate as the firm and the required rate of return on Burness stock is 12 percent,
what is the market value of the companys stock? (LO 4)
SM 9-40
Solutions Manual
Solution:
D0 = $1.50;
P0
g = 5.5%;
R = 12%
D1
$1.50 1.055
$24.35
R g 0.12 0.055
AASCB: Analytic
AICPA: Measurement
9.4
Abacus Corporation will pay dividends of $2.25, $2.95, and $3.15 in the next three years.
After three years, the dividends are expected to grow at a constant rate of 4 percent per
year. If the required rate of return is 14.5 percent, what is the current value of the Abacus
common stock? (LO 4)
Solution:
gconstant = 4%; D1 = $2.25 D2 = $2.95 D3 = $3.15; R = 14.5%
P3
D4
$3.15 1.04
$31.20
R g 0.145 .04
$2.25
$2.95
$3.15
$31.20
2
3
(1.145) (1.145) (1.145) (1.145)3
$1.97 $2.25 $2.10 $20.78
P0
$27.10
AASCB: Analytic
AICPA: Measurement
9.5
The preferred stock of Wellcare Inc. is currently trading at $137.50 per share. If the
required rate of return is 8 percent and this stock has no maturity date, what is the
SM 9-41
Solutions Manual
quarterly dividend paid by this stock? What is the quarterly dividend if the stock will
mature in one year and it has a par value of $140? (LO 6)
Solution:
With no maturity date:
PS0 = $137.5; R = 8.0%
D
PS0 $137.50
0.08
D $137.50 0.08
$11.00
Annual dividend = $11.00
Quarterly dividend = $11.00 /4 = $2.75
SM 9-42
Solutions Manual
We can use Equation 9.7 to solve for the dividend with a one year maturity date:
PS0
D/m Pmn
D/m
D/m
D/m
2
3
(1 i / m) (1 i / m) (1 i / m) (1 i / m) 4
$137.50
D/m
D/m
D/m
D/m $140
2
3
(1 0.08 / 4) (1 0.08 / 4) (1 0.08 / 4) (1 0.08 / 4) 4
$137.50
D/m
D/m
D/m D/m $140
2
1.02 (1.02) (1.02)3
(1.02)4
Using a financial calculator to solve for PMT, we find that the quarterly dividend, D/m =
$2.14.
AASCB: Analytic
AICPA: Measurement
SM 9-43

CH 09

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH 09

Uploaded by

Copyright:

Available Formats

Fundamentals of Corporate Finance, 3rd edition

2. How do dealers differ from brokers?

Fundamentals of Corporate Finance, 3rd edition

4. What does the price-earnings ratio tell us?

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Why can skipping payment of a preferred dividend be a bad signal?

How is a preferred stock with a fixed maturity valued?

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Self- Study Problems

D0 (1 + g1) = $2.50(1 + 0.30) = $3.25

D1 (1 + g2) = $3.25(1 + 0.25) = $4.06

D2 (1 + g3) = $4.06(1 + 0.15) = $4.67

Present value of the dividends = PV(D1) + PV(D2) + PV(D3)

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

D5 = D4 (1 + g5) = $1.485(1 + 0.35) = $2.005

(1.17)3 (1.17) 4 (1.17)5

Current value of stock = PV(Dividends) + PV(P5)

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

in other words, the stock of a mature

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Explain why preferred stock is considered to be a hybrid of equity and debt

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Why is stock valuation more difficult than bond valuation?

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Questions and Problems

Stock Market Index: What is a stock market index?

Stock Market Index: What is the Dow Jones Industrial Average?

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Dividend yield: What is a dividend yield? What does it tell us?

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Present value of dividends: Fresno Corp. is a fast-growing company whose

D1 = D0 (1 + g1) = $2.15(1.30) = $2.795

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

$37.50(0.14 g ) $2.25 2.25 g

$37.50(0.14 g ) $2.25 2.25 g

Copyright 2015 John Wiley & Sons, Inc.

Fundamentals of Corporate Finance, 3rd edition

Constant growth: Proxicam, Inc., is expected to grow at a constant rate of 7 percent. If

0.0515 0.07 12.15%