CHAPTER 4

The Value of Common Stocks

15.
Horizon
Period (H)

16.

Expected Future Values

Present Values
Dividend
Price
Cumulative
Future
(DIVt )
(Pt )
Dividends
Price

0
100.00
100.00
1
10.00
105.00
8.70
91.30
2
10.50
110.25
16.64
83.36
3
11.03
115.76
23.88
76.12
4
11.58
121.55
30.50
69.50
10
15.51
162.89
59.74
40.26
20
25.27
265.33
83.79
16.21
50
109.21
1,146.74
98.94
1.06
100
1,252.39
13,150.13
99.99
0.01
Assumptions
1.
Dividends increase at 5% per year compounded.
2.
Capitalization rate is 15%.
PA = $100

Total
100.00
100.00
100.00
100.00
100.00
100.00
100.00
100.00
100.00

PB = $83.33
PC = $104.50
At a capitalization rate of 10%, Stock C is the most valuable.
For a capitalization rate of 7%:
PA = $142.86
PB = $166.67
PC = $156.48
17.

Therefore, Stock B is the most valuable.

a.
P0 = $21.90
b.
P0 = $21.90 (r=6.57%, g=0)

18.

a.
Year
0
1
2
3
4
5

EPS and dividends for subsequent years are:

EPS
$7.00
$7.00 1.07 = $7.4900
$7.00 1.072 = $8.0143
$7.00 1.073 = $8.5753
$7.00 1.074 = $9.1756
$7.00 1.074 1.023 = $9.3866

DIV
$7.00 0.5 = $3.50
$7.4900 0.5 = $3.50 1.07 = $3.7450
$8.0143 0.5 = $3.50 1.072 = $4.0072
$8.5753 0.5 = $3.50 1.073 = $4.2877
$9.1756 0.5 = $3.50 1.074 = $4.5878
$9.3866 0.5 = $3.50 1.074 1.023 = $4.6933

EPS and dividends for year 5 and subsequent years grow at 2.3% per
year, as indicated by the following calculation:
Dividend growth rate = 0.023
b.
P0 = $45.65

19.

a.
b.

20.

The security analysts forecast is wrong because it assumes a perpetual constant

growth rate of 15% when, in fact, growth will continue for two years at this rate
and then there will be no further growth in EPS or dividends.
The value of the companys stock is the present value of the expected dividend
of $2.30 to be paid in 2020 plus the present value of the perpetuity of $2.65
beginning in 2021. Therefore, the actual expected rate of return is the solution
for r in the following equation:
r = 12.01%
a.
P = $23.81

23.

24.

r = 11.75%
g = 6.0%
P0 = 147.83

b.

PV(PH) = $22.07

c.

PVGO = $31.00 $20.75 = $10.25

d.

The new stock price will be: $23.81 $7.30 = $16.51

a.

r = 8.0%
PVGO = $16.63

25.

26.

b.

P0 = $106.21

a.

PV per Share = $62.78

b.

EPS/P = $10.29/$62.78 = 0.164

Present value of the business is: = $26.16 million

27.
28.

$10 million; 12.5 million