1. A share of common stock will pay a dividend of $2.50 next year. If the stock
ID: 2614634 • Letter: 1
Question
1. A share of common stock will pay a dividend of $2.50 next year. If the stock price is currently $25 and the constant growth rate is 6%, then what is the rate of return (Rs)?
a. 6% b. 10%
c. 11% d. 16%
e. 17%
2. A share of common stock just paid a dividend of $1.00. If the rate of return (Rs) is 10% and the constant growth rate is 5%, then what is the price of the stock?
a. $10.00 b. $10.50
c. $20.00 d. $21.00
e. $22.00
3. Cash flow to a firm is $45 million for the next year. Cash flow will grow continuously at 5% forever. The firm has $100 million in debt and 50 million shares outstanding. If the rate of return (WACC) is 10%, then what is the price of the stock?
Stock Price Today, P0 = ________
Explanation / Answer
1.Rate of return=(D1/Current price)+Growth rate
=(2.5/25)+0.06
=16%
2.
Current price=D1/(Required return-Growth rate)
=(1*1.05)/(0.1-0.05)
=$21
3.
Value after next year=(Cash flow for next year*Growth rate)/(WACC-Growth rate)
=(45*1.05)/(0.1-0.05)=$945million
Total current value=Future cash flows*Present value of discounting factor(10%,time period)
=45/1.1+945/1.1
=$900million
Hence value of common stock=(Total current value-Value of debt)
=(900-100)=$800million
Hence price of the stock=$800million/50million shares
=$16.
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