Fin 515 Valuing Stocks

Chapter 9

Valuing Stocks

9-1. Assume Evco, Inc., has a current price of $50 and will pay a $2 dividend in one year, and its equity cost of capital is 15%. What price must you expect it to sell for right after paying the dividend in one year in order to justify its current price? We can use Eq. (9.1) to solve for the price of the stock in one year given the current price of $50.00, the $2 dividend, and the 15% cost of capital.

50 

2 X 1.15 X  55.50

At a current price of $50, we can expect Evco stock to sell for $55.50 immediately after the firm pays the dividend in one year. 9-4. Krell Industries has a share price of $22 today. If Krell is expected to pay a dividend of $0.88 this year, and its stock price is expected to grow to $23.54 at the end of the year, what is Krell’s dividend yield and equity cost of capital? Dividend Yield = 0.88 / 22.00 = 4% Capital gain rate = (23.54 – 22.00) / 22.00 = 7% Total expected return = rE = 4% + 7% = 11% 9-5. NoGrowth Corporation currently pays a dividend of $2 per year, and it will continue to pay this dividend forever. What is the price per share if its equity cost of capital is 15% per year? With the simplifying assumption (as was made in the chapter) that dividends are paid at the end of the year, then the stock pays a total of $2.00 in dividends per year. Valuing this dividend as a perpetuity, we have, P  $2.00 / 0.15  $13.33 . Alternatively, if the dividends are paid quarterly, we can value them as a perpetuity using a quarterly discount rate of (1.15) 4  1  3.556% (see Eq. 5.1). Then P  $0.5010.03556  $14.06 . 9-6. Summit Systems will pay a dividend of $1.50 this year. If you expect Summit’s dividend to grow by 6% per year, what is its price per share if its equity cost of capital is 11%? P = 1.50 / (11% – 6%) = $30 9-7. Dorpac Corporation has a dividend yield of 1.5%. Dorpac’s equity cost of capital is 8%, and its dividends are expected to grow at a constant rate. a. b. What is the expected growth...