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Ch 9 - Stock Valuation Questions and Answers
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Ch 9 - Stock Valuation Questions and Answers What makes up the price of stock? 1. Dividends 2. Capital gains -The discounted present value of the sum of next period's dividend plus next period's stock price -The discounted present value of all future dividends P0 = [(Div1)/(1+R)] + [P1/...

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  • December 15, 2024
  • 6
  • 2024/2025
  • Exam (elaborations)
  • Questions & answers

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  • ch 9 stock valuation questions and answers
  • zero growth the price of a share of stock with a c
  • constant growth the price of a share of stock with

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Ch 9 - Stock Valuation Questions and
Answers
What makes up the price of stock? - answer 1. Dividends
2. Capital gains

-The discounted present value of the sum of next period's dividend plus next period's
stock price

-The discounted present value of all future dividends

P0 = [(Div1)/(1+R)] + [P1/(1+R)]
where Div 1 = expected dividend paid at year's end
P1 = expected price at year's end
R = discount rate

Zero growth - answer The price of a share of stock with a constant dividend is given
by:

P0 = [Div1/(1+R)] + [Div2/(1+R)^2] ...

assume that Div1 = Div2 = ...

Constant growth - answer The price of a share of stock with a constant growth rate is
given by:

P0 = [Div/(1+R)] + [Div*(1+g)/(1+R)^2)] + [Div*(1+g)^2/(1+R)^3] + [Div*(1+g)^3/(1+R)^4]
... = Div/(R-g)

where g = growth rate
Div = dividend on the stock at the end of the first period

Suppose an investor is considering the purchase of a share of the Utah Mining
Company. The stock will pay a $3 dividend a year from today. This dividend is expected
to grow at 10 percent per year (g = 10%) for the foreseeable future. The investor thinks
that the required return (R) on this stock is 15 percent, given her assessment of Utah
Mining's risk. (We also refer to R as the discount rate of the stock.) What is the price of
a share of Utah Mining Company's stock? - answer P0 = Div / (R-g) = 3 / (.15-.10) =
60

Consider Elixir Drug Company, which is expected to enjoy rapid growth from the
introduction of its new back-rub ointment. The dividend for a share of Elixir's stock a
year from today is expected to be $1.15. During the next four years, the dividend is

, expected to grow at 15 percent per year (g1= 15%). After that, growth (g2) will be equal
to 10 percent per year. Calculate the present value of a share of stock if the required
return (R) is 15 percent. - answer PV of dividends Y1-5 = $5

P5 = 44.25

P5 / (1+R)^5 = 22

22+5 = 27

Retention ratio - answer Ratio of retained earnings to earnings

Retained earnings divided by net income. Also called the plowback ratio

1 + g = 1 + Retention ratio x Return on retained earnings

Return on equity - answer Net income divided by total equity. Measures the profit per
dollar of book equity

Formula for firm's growth rate - answer g = Retention ratio x ROE

Pagemaster Enterprises just reported earnings of $2 million. The firm plans to retain 40
percent of its earnings in all years going forward. In other words, the retention ratio is 40
percent. We could also say that 60 percent of earnings will be paid out as dividends.
The ratio of dividends to earnings is often called the payout ratio, so the payout ratio for
Pagemaster is 60 percent. The historical return on equity (ROE) has been .16, a figure
expected to continue into the future. How much will earnings grow over the coming
year? - answer Retained Earnings = (2,000,000)*(.40) = 800,000

ROE = (800,000)*.16 = 128,000

g = Retention Ratio x ROE = (.40)*(.16) = .064

Change in earnings / total earnings = 128,000/2,000,000 = .064

Dividend yield - answer Dividends per share of common stock divided by market
price per share.

= Div/P0

Capital gains yield - answer The rate at which the value of an investment grows

This is also the same as the dividend growth rate and the stock price's growth rate,
denoted g

How do you find R? - answer = Dividend yield + Capital gains yield = (Div/P0) + g

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