Chapter: Stock Valuation

Problems

9-2:Tresnan Brothers is expected to pay a $1.80 per share dividend at the end of the year (i.e.,

D1 = $1.80). The dividend is expected to grow at a constant rate of 4% a year. The required rate
of return on the stock, rs , is 10%. What is the stock’s current value per share?

9-3: Holtzman Clothiers’ stock currently sells for $38.00 a share. It just paid a dividend of $2.00
a share (i.e., Do = $2.00). The dividend is expected to grow at a constant rate of 5% a year. What
stock price is expected 1 year from now? What is the required rate of return?

9-4: Holt Enterprises recently paid a dividend, Do of $2.75. It expects to have nonconstant
growth of 18% for 2 years followed by a constant rate of 6% thereafter. The firm’s required
return is 12%.

a. How far away is the horizon date?

b. What is the firm’s horizon, or continuing, value?

c. What is the firm’s intrinsic value today, Po?

9-11: A stock is expected to pay a dividend of $2.75 at the end of the year (i.e., D1 = $2.75), and
it should continue to grow at a constant rate of 5% a year. If its required return is 15%, what is
the stock’s expected price 4 years from today?

9-12: Investors require an 8% rate of return on Mather Company’s stock (i.e., rs = 8%).

a. What is its value if the previous dividend was Do = $1.25 and investors expect dividends to
grow at a constant annual rate of (1) -2%, (2) 0%, (3) 3%, or (4) 5%?

b. Using data from part a, what would the Gordon (constant growth) model value be if the
required rate of return was 8% and the expected growth rate was (1) 8% or (2) 12%? Are these
reasonable results? Explain.
c. Is it reasonable to think that a constant growth stock could have g > rs? Why or why not?

9-13: You are considering an investment in Justus Corporation’s stock, which is expected to pay

a dividend of $2.25 a share at the end of the year (D1 = $2.25) and has a beta of 0.9. The risk-
free rate is 4.9%, and the market risk premium is 5%. Justus currently sells for $46.00 a share,
and its dividend is expected to grow at some constant rate, g. Assuming the market is in
equilibrium, what does the market believe will be the stock price at the end of 3 years? (That is,

what is P3?)

9-14: Computech Corporation is expanding rapidly and currently needs to retain all of its
earnings; hence, it does not pay dividends. However, investors expect Computech to begin
paying dividends, beginning with a dividend of $0.50 coming 3 years from today. The dividend
should grow rapidly at a rate of 35% per year during Years 4 and 5, but after Year 5, growth
should be a constant 7% per year. If the required return on Computech is 13%, what is the value
of the stock today?

9-16: Carnes Cosmetics Co.’s stock price is $30, and it recently paid a $1.00 dividend. This
dividend is expected to grow by 30% for the next 3 years, then grow forever at a constant rate, g

and rs = 9%. At what constant rate is the stock expected to grow after Year 3?

9-17: CONSTANT GROWTH Your broker offers to sell you some shares of Bahnsen & Co.
common stock that paid a dividend of $2.00 yesterday. Bahnsen’s dividend is expected to grow
at 5% per year for the next 3 years. If you buy the stock, you plan to hold it for 3 years and then
sell it. The appropriate discount rate is 12%.

a. Find the expected dividend for each of the next 3 years; that is, calculate D1, D2, and D3.
Note that Do = $2.00.

b. Given that the first dividend payment will occur 1 year from now, find the present value of
the dividend stream; that is, calculate the PVs of D1, D2, and D3, and then sum these PVs.
c. You expect the price of the stock 3 years from now to be $34.73; that is, you expect P3 to
equal $34.73. Discounted at a 12% rate, what is the present value of this expected future stock
price? In other words, calculate the PV of $34.73.

d. If you plan to buy the stock, hold it for 3 years, and then sell it for $34.73, what is the most
you should pay for it today?

e. Use Equation 9.2 to calculate the present value of this stock. Assume that g = 5% and that it is
constant.

f. Is the value of this stock dependent upon how long you plan to hold it? In other words, if your
planned holding period was 2 years or 5 years rather than 3 years, would this affect the value of

the stock today, Po? Explain.

9-18: NONCONSTANT GROWTH STOCK VALUATION Taussig Technologies

Corporation (TTC) has been growing at a rate of 20% per year in recent years. This same growth

rate is expected to last for another 2 years, then decline to gn = 6%.

a. If Do = $1.60 and rs = 10%, what is TTC’s stock worth today? What are its expected
dividend, and capital gains yields at this time, that is, during Year 1?

b. Now assume that TTC’s period of supernormal growth is to last for 5 years rather than 2
years. How would this affect the price, dividend yield, and capital gains yield? Answer in words
only.

c. What will TTC’s dividend and capital gains yields be once its period of supernormal growth
ends? (Hint: These values will be the same regardless of whether you examine the case of 2 or 5
years of supernormal growth; the calculations are very easy.)

d. Explain why investors are interested in the changing relationship between dividend and capital
gains yields over time.

9-21: NONCONSTANT GROWTH Assume that it is now January 1, 2019. Wayne-Martin

Electric Inc. (WME) has developed a solar panel capable of generating 200% more electricity
than any other solar panel currently on the market. As a result, WME is expected to experience a
15% annual growth rate for the next 5 years. Other firms will have developed comparable
technology by the end of 5 years, and WME’s growth rate will slow to 5% per year indefinitely.

Stockholders require a return of 12% on WME’s stock. The most recent annual dividend ( Do),
which was paid yesterday, was $1.75 per share.
a. Calculate WME’s expected dividends for 2019, 2020, 2021, 2022, and 2023.

b. Calculate the value of the stock today, Po. Proceed by finding the present value of the
dividends expected at the end of 2019, 2020, 2021, 2022, and 2023 plus the present value of the
stock price that should exist at the end of 2023. The year end 2023 stock price can be found by
using the constant growth equation. Notice that to find the December 31, 2023, price, you must
use the dividend expected in 2024, which is 5% greater than the 2023 dividend.

c. Calculate the expected dividend yield ( D1 / Po), capital gains yield, and total return (dividend

yield plus capital gains yield) expected for 2019. (Assume that Po = Po and recognize that the
capital gains yield is equal to the total return minus the dividend yield.) Then calculate these
same three yields for 2024.

d. How might an investor’s tax situation affect his or her decision to purchase stocks of
companies in the early stages of their lives, when they are growing rapidly, versus stocks of
older, more mature firms? When does WME’s stock become “mature” for purposes of this
question?

e. Suppose your boss tells you she believes that WME’s annual growth rate will be only 12%
during the next 5 years and that the firm’s long-run growth rate will be only 4%. Without doing
any calculations, what general effect would these growth rate changes have on the price of
WME’s stock?

f. Suppose your boss also tells you that she regards WME as being quite risky and that she
believes the required rate of return should be 14%, not 12%. Without doing any calculations,
determine how the higher required rate of return would affect the price of the stock, the capital
gains yield, and the dividend yield. Again, assume that the long-run growth rate is 4%