Hsa 525

Assignment Three

Andre` Williams

Dr. Melody Princess-Kelley

HSA 525

May 16, 2011

What is the stock’s value?

When E(g) is assumed to be constant, a stock can be valued using the constant growth model:

E(Po) = Do x [1 + E(g)] = E(D1)____

R(Re) – E(g) R(Re) – E(g)

E(Po) = $2.00 x 1.05 = $2.10 = $21.00 is the stock’s value

0.15 - .05 = 0.10

Suppose the riskiness of the stock decreases, which causes the required rate of return to fall to 13%. Under these conditions, what is the stock’s value?

E(Po) = Do x [1 + E(g)] = E(D1)____

R(Re) – E(g) R(Re) – E(g)

E(Po) = $2.00 x 1.05 = $2.10 = $26.25 is the stock’s value

.13 - .05 0.08

Return to the original 15% required rate of return and assume a dividend growth rate estimate increase to 7% per year, what is the stock value?

E(Po) = Do x [1 + E(g)] = E(D1)____

R(Re) – E(g) R(Re) – E(g)

E(Po) = $2.00 x 1.07 = $2.14 = $26.75 is the stock’s value

.15 – 0.07 0.08

Explain how each of the four (4) fundamental factors that affect the supply and demand for investment capital, and hence, interest rates, (namely productive opportunities, time preferences for consumption, risk, and inflation) affects the cost of money.

The four fundamental factors that affect the cost of money are production opportunities, time preferences for consumption, risk, and inflation. Production opportunities are a company’s ability to turn money into benefits. If a company raises money the benefits are determined by the expected rates of return on its production opportunities. If a homeowner borrows money, the benefits are the pleasure from living in their own home and any expected appreciation in the value of the home (Brigham & Ehrhardt, n.d.). The time preference for consumption has a major impact on the cost of money. Individuals can use their money for consumption or saving....