Question

WORK tool Problem Walk-Through 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 - $1.50 and investors expect dividends to grow at a constant annual rate of (1) -6%, (2) 0%, (3) 3%, or (4) 7%? Do not round intermediate calculations. Round your answers to the nearest cent. (1) $ (2) $ (3) $ 10. b. Using data from part a, what would the Gordon (constant growth) model value be the required rate of return was 8% and the expected growth rate was (1) 8% or (2) 12%? Round your answers to the nearest cent. If the value is undefined, enter N/A (1) $ (2) $ Are these reasonable results? 1. These results show that the formula makes sense of the required rate of return is equal to or greater than the expected growth rate. II. These results show that the formula does not make sense if the expected growth rate is equal to or less than the required rate of return III. These resuts show that the formula does not make sense of the required rate of return is equal to or less than the expected growth rate. TV. These results show that the formula does not make sense of the required rate of return is equal to or greater than the expected growth rate. V. These results show that the formula makes sense of the required rate of return is equal to or less than the expected growth rate. -Select- c. Is it reasonable to think that a constant growth stock could have g ? L It is not reasonable for a firm to grow indefinitely at a rate equal to its required return IL It is not reasonable for a firm to grow indefinitely at a rate higher than its required return TIL It is reasonable for a firm to grow indefinitely at a rate higher than its required retum. IV. It is not reasonable for a firm to grow even for a short period of time at a rate higher than is required return V. It is not reasonable for a firm to grow indefinitely at a rate lower than is required return

Answer 1

Value of stock = Next expected dividend/(required rate of return – growth rate)

(1)Value = 1.50(1-6%)/(8%+6%) = $10.07

(2)Value = 1.50(1+0%)/(8%-0%) = $18.75

(3)Value = 1.50(1+3%)/(8%-3%) = $30.9

(4)Value = 1.50(1+7%)/(8%-7%) = $160.5

b.Value = 1.50(1+8%)/(8%-8%) = not defined

At 12%, value = -42

Will provide negative value when g>required rate of return

III. Does not make sense when the required rate of return is equal to or less than the expected growth rate

c.III. Reasonable