6.1 Stock Valuation Methods Flashcards
The corporation just paid a dividend of $2.00 per common share. Historical data indicate dividends grow at a steady rate of 5% per year. The required rate of return for investing in such stock is 18%. The current value of one share of the corporation’s common stock is
A. $16.15
B. $15.38
C. $11.67
D. $11.11
A. $16.15
Next Dividend = $2.00 x 1.05 = $2.10
Using the constant growth dividend discount model
Dividend per share / (Discount rate - Dividend growth rate)
$2.10 / (18% cost of capital - 5% dividend growth rate) = $16.15
A financial analyst is using the two-stage model of dividend growth to value a corporation that paid an annual dividend last year of $4 per share. The annual dividend is assumed to grow at 10% per year for the next 3 years and then grow at 5% per year thereafter. A 12% required return is assumed. Which change in one of the assumptions would cause the analyst to find a higher value for the stock?
A. The required return is changed from 12% to 14%.
B. The growth rate is changed from 5% to 4%.
C. The 3-year assumption is changed to 5 years.
D. The 10% growth rate is changed to 8%.
C. The 3-year assumption is changed to 5 years.
A company is projecting an annual growth rate for the foreseeable future of 9%. The most recent dividend paid was $3.00 per share. New common stock can be issued at $36 per share. Using the constant growth model, what is the approximate cost of capital for retained earnings?
A. 9.08%
B. 17.33%
C. 18.08%
D. 19.88%
C. 18.08%
The cost of capital can be found using the dividend discount model. In the calculation below, x is the cost of capital.
Price = Next period dividend ÷ (Cost of capital – Dividend growth rate)
Price = [Current period dividend × (1 + Growth rate)] ÷ (Cost of capital – Dividend growth rate)
$36 = ($3.00 × 1.09) ÷ (x – 9%)
$36x – $3.24 = $3 × 1.09
$36x – $3.24 = $3.27
$36x = $6.51
x = 18.08333 or 18.08%
Price = Next period dividend ÷ (Cost of capital – Dividend growth rate)
Price = [Current period dividend × (1 + Growth rate)] ÷ (Cost of capital – Dividend growth rate)
$36 = ($3.00 × 1.09) ÷ (x – 9%)
$36x – $3.24 = $3 × 1.09
$36x – $3.24 = $3.27
$36x = $6.51
x = 18.08333 or 18.08%
A public company’s shareholders expect to receive a dividend 1 year from now of $20 per share. Immediately after the dividend payout, analysts are expecting that the stock will trade at $244 per share. If the investors have a required rate of return of 20%, what is the current value of the stock?
A. $220
B. $224
C. $244
D. $264
A. $220
One method of valuing stock is shareholder return, which measures the return on a purchase of stock. Shareholder return is equal to the required rate of return. In this case, the current value of the stock is equal to the beginning stock price. In the calculation below, x is the beginning stock price.
Shareholder return = (Ending stock price – Beg. stock price + Annual dividends per share) ÷ Beg. stock price
20% = ($244 – x + $20) ÷ x
0.2x = $264 – x
1.2x = $264
x = $220
The common stock of a company is currently selling at $80 per share. The leadership of the company intends to pay a $4 per share dividend next year. With the expectation that the dividend will grow at 5% perpetually, what will the market’s required return on investment be for the common stock?
A. 5%
B. 5.25%
C. 7.5%
D. 10%
D. 10%
The dividend growth model estimates the cost of retained earnings using the dividends per share, the market price, and the expected growth rate. The current dividend yield is 5% ($4 ÷ $80). Adding the growth rate of 5% to the yield of 5% results in a required return of 10%.
