Q1: Dividend discount model. Amazon.com has never paid a dividend, but in august

Question

Q1: Dividend discount model. Amazon.com has never paid a dividend, but in august 2010 the market value of its stock was $57 billion. Does this invalidate the dividend discount model?

Q2: Dividen Yield. Favored stock will pay a dividend this year of $2.40 per share. Its dividend yield is 8%. At what price is the stock selling?

Q3: Preferred stock. Preferred producsts has issued preferred stock with an $8 annual dividend that will be paid in perpetuity.

a) If the discount rate is 12%, at what price should the preferred sell?
b) At what price should the stock sell 1 year from now?
c) What is the dividend yield, the capital gains yield, and the expected rate of return



YEAR PROJECT A PROJECT B
0 -$200 -$200
1 $80 $100
2 $80 $100
3 $80 $100
4 $80

Q4: IRR/NPV. If the opportunity cost of capital is 11%, which of these projects is worth pursuing?

Q5: Mutually Exclusive Investments: Suppose that you can choose only one of these projects, which would you choose? The discount rate is still 11%.

Q6: IRR. What are the internal rates of return on Projects A and B?

Explanation / Answer

(q1)
To use the dividend discount model, the company must have paid dividends and there must be future expectations of dividends. If it does not that means the payout ratio is 0%, so we need to know the earnings of the stock to discount them to get the price of stock.

(q2)
Price of stock = dividend/dividend yield = 2.4/8% = 30

(q3)
(a)
Price of stock = dividend/discount rate = 8/12% = 66.67
(b)
It will be selling at the same price. Because the dividend is paid in perpetuity meaning it does not change the pv. (infinite remaining cash flows last year and this year)
(c)
Capital gain yield is 0% (as the price is not changing)
Dividend yield is 12% (same discount rate used for paying the dividend)
Total yield = (1+0%)*(1+12%) -1= 12%

(q4)

NPV = -initial amount + discounted cash flows
NPV of A = 75.49
NPV of B = 71.25

A has higher NPV so it is worth.

(q5)
We must choose the one with more NPV. So we must choose A

(q6)
From excel:
IRR of A = 21.862
IRR of B = 23.375
By IRR we must choose the one with most IRR, that will be B

Please rate my answer!
Thanks in advance :)

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