Question

FNB 100-Professor Early ASSIGNMENT Valuation of Equity Prices Question #1. How can the analysis of risk be integrated into the valuation of common stock? What should happen to the value of common stock if its beta increases? Problem #1. What should be the price of the following preferred stock it comparable securities yield 7. a) Preferred stock A is estimated to pay an $8.00 dividend. b) Preferred stock B is estimated to pay an $8.00 а» dividend but will be retired after 20 years at its par value of $100.00 c) What are the valuations different? Problem 62 As an investor you have a required return of 14% for investments in common stocks. You have analyzed three firms and must decide which stock (if any) to purchase. Your information is as f。llows: FIRM CURRENT DIVIDENDS $1.00 $3.00 $7.50 Same as 10 year when EXPECTED ANNUAL GROWTH RATE IN DIVIDENDS (AND $0.50 2% -1% CURRENT MARKET PRICE OF THE STOCKS $23.00 $47.00 $60.00 Using the Dividend Growth Model: V (D) (1+g) /K-G: a) What is the maximum price that yoù should pay for each stock? Which stock should you purchase (if any)? b) If you purchased Firm A stock, what would your implied required rate of return? c) If.your required rate of return was 10%, what would be the price necessary to induce you to buy stock A2

Answer 1

Question 1: The analysis of risk can be taken into account in the expected return of the stock in the valuation of common stock.

The expected return of the stock is calculated as = risk free return + beta * market risk premium.

When the risk increases, the beta increases which will increase the expected return on the stock. As the expected return increases. Using the expected return, the current price of the stock is calculated as = D1/(r -g) where D1 is the next expected dividend, r is the expected return on the stock and g is the growth rate of dividends.

Problem 1:

a. Price of the preferred stock A = Dividend/ Expected return = 8.00/0.07 = $114.28

b. Price of preferred stock stock B = Price *(1-(1+r)^-n)/r = 8*(1-1.07^-20)/0.07 = $84.75

c. the valuations are difference since preferred stock A is a perpetuity and preferred stock B is a annuity with 20 years life

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