Elk County Telephone has paid the dividends shown in the following table over th
ID: 2712089 • Letter: E
Question
Elk County Telephone has paid the dividends shown in the following table over the previous 6 years:
Year / Dividend per share
The firm's dividend per share next year is expected to be $7.16.
A. If you can earn 15% on similar-rish investments, what is the most you would be willing to pay per share?
B. If you can earn only 12% on similar -risk investments, what is the most you would be willing to pay per share?
c. According to the findings in part a and b, as risk decreases, the required rate of return (increases/decreases), causing the share price to (fall/rise)
Explanation / Answer
Growth rate in dividends:
= ($7.16÷$6)^(1÷6)-1
= 3%
a)
Stock price = D1÷(r-g)
D1 is next expected dividend
r is required return
g is growth rate
= $7.16÷(15%-3%)
= $59.67
b)
Stock price = D1÷(r-g)
D1 is next expected dividend
r is required return
g is growth rate
= $7.16÷(12%-3%)
= $79.56
c)
If required rate of return decreases, causing share price to rise.
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