Question

QUESTION 16 XYZ common stock sells for $15 and just paid a $2 dividend per share, which is expected to grow at a rate of 5% indefinitely. You require a 20% rate of return. Should you buy the stock today if you expect to sell it in four years for $259 Yes No You'd be indifferent between buying the stock and not doing so Cannot be determined. Click Save and Submit to save and submit. Click Save All Answers to save all answers. Save All Answers MacBook Pro

Answer 1

Answer to Question 16 is “Yes”:

Last Dividend, D0 = $2.00
Growth Rate, g = 5%

D1 = $2.0000 * 1.05 = $2.1000
D2 = $2.1000 * 1.05 = $2.2050
D3 = $2.2050 * 1.05 = $2.3153
D4 = $2.3153 * 1.05 = $2.4311

Stock Price in Year 4, P4 = $25.00
Required Return, rs = 20%

Intrinsic Value, P0 = D1/(1+rs) + D2/(1+rs)^2 + D3/(1+rs)^3 + D4/(1+rs)^4 + P4/(1+rs)^4
Intrinsic Value, P0 = $2.10/1.20 + $2.205/1.20^2 + $2.3153/1.20^3 + $2.4311/1.20^4 + $25.00/1.20^4
Intrinsic Value, P0 = $17.85

Intrinsic value of stock is higher than current price of stock, so you should buy the stock today.

Answer to Question 17 is “$8.98”:

D1 = $1.00
D2 = $0.90
D3 = $0.85

Required Return, rs = 8.00%
Growth Rate, g = -2.00%

D4 = D3 * (1 + g)
D4 = $0.85 * (1 - 0.02)
D4 = $0.833

P3 = D4 / [rs - g]
P3 = $0.833 / [0.08 - (-0.02)]
P3 = $0.833 / 0.10
P3 = $8.33

P0 = $1.00/1.08 + $0.90/1.08^2 + $0.85/1.08^3 + $8.33/1.08^3
P0 = $8.98

The stock should be worth $8.98