MINDTAP Tamia Hilton(? ham Chapter 09 End-of-Chapter Problems 9-12 Investors req

Question

MINDTAP Tamia Hilton(? ham Chapter 09 End-of-Chapter Problems 9-12 Investors require a 15% rate of return on levine company's stock (Le.. rs-15%). a. What is its value if the previous dividend was D-$1.25 and investors expect dividends to grow at a constant annual rate of (1)-3, (2) 0%, (3) 2%, or (4) 14967 Round your answers to two decimal places. O (1)s (2) s (3) s (4) $ b. Using data from part a, what would the Gordon (constant (2) 20%? Are these reasonable results? 1. The results show that the formula does not make sense if the required rate of return is equal to or less than the expected growth rate. Il. The resulits show that the formula does not make sense if the required rate of return is equal to or greater than the expected growth rate. It. The results show that the formula makes sense if the required rate of return is equal to or less than the expected growth rate. results show that the formula makes sense if the required rate of return is equal to or greater than the expectedg V. 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. c. ts it reasonable to think that a constant growth stock could have g > IL. It is not reasonable for a firm to grow even for a short period of time at a rate higher than its required returm. III. It is not reasonable for a firm to grow IV. It is not reasonable for a firm to grow V. It is not reasonable for a firm to grow indefinitely at a rate higher than its required return itely at a rate lower than its required return. at a rate equal to its required return 2

Explanation / Answer

(a) The Constant Growth Model determines the stock price as given below:

P0 = D1 / (r-g) where D1 is the expected dividend next year, r is the required rate of return and g is the annual dividend growth rate.

(i) D0 = $ 1.25 and g = - 3 %, Required Return = 15 %

D1 = 1.25 x 0.97 = $ 1.164

P0 = 1.164 / (0.15 - (-0.03)) = $ 6.467

(ii) D0 = $ 1.25 and g = 0 %, Required Return = 15 %

D1 = 1.25 x 1 = $ 1.25

P0 = 1.25 / 0.15 = $ 8.333

(iii) D0 = $ 1.25 and g = 2 %, Required Return = 15 %

D1 = 1.25 x 1.02 = $ 1.275

P0 = 1.275 / (0.15 - 0.02) = $ 9.808

(iv) D0 = $ 1.25 and g = 14 %, Required Return = 15 %

D1 = 1.25 x 1.14 = $ 1.425

P0 = 1.425 / (0.15 - 0.14) = $ 14.25

NOTE: Please raise separate queries for solutions to the remaining sub-parts.

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