1. Anderson Motors Inc. has just set the company dividend policy at $0.50 per ye
ID: 2744341 • Letter: 1
Question
1. Anderson Motors Inc. has just set the company dividend policy at $0.50 per year. The company plans to be in business forever. What is the price of this stock if
a. An investor wants a 5% return?
b. An investor wants an 8% return?
c. An investor wants a 10% return?
d. An investor wants a 13% return?
e. An investor wants a 20% return?
Answer: Use the constant dividend infinite dividend stream model:
Price = Dividend/r
a.
b.
c.
d.
e.
2. King Waterbeds has an annual cash dividend policy that raises the dividend each year by 4%. Last year’s dividend was $0.40 per share. What is the price of this stock if
a. an investor wants a 5% return?
b. an investor wants an 8% return?
c. an investor wants a 10% return?
d. an investor wants a 13% return?
e. an investor wants a 20% return?
Answer: Use the constant growth dividend model with infinite horizon:
Price = Last Dividend ´ (1 + g)/(r - g)
a.
b.
c.
d.
e.
3. Martin Winery wants to raise $10 million from the sale of preferred stock. If the winery wants to sell 1 million shares of preferred stock, what annual dividend will it have to promise if investors demand the following return:
a. 12%.
b. 18%.
c. 8%.
d. 6%.
Answer: Use the constant dividend model with infinite horizon, rearranged for the dividend:
Dividend = r ´ Price
The price of the shares is $10,000,000/1,000,000 = $10.00 per share
Explanation / Answer
1
Formula
Price per share
a.
$0.50/0.05
$ 10.00
b.
$0.50/0.08
$ 6.25
c.
$0.50/0.10
$ 5.00
d.
$0.50/0.13
$ 3.85
e.
$0.50/0.20
$ 2.50
2
Formula
Price per share
a.
($0.40*1.04) / (0.05-0.04)
$ 41.60
b.
($0.40*1.04) / (0.08-0.04)
$ 10.40
c.
($0.40*1.04) / (0.10-0.04)
$ 6.93
d.
($0.40*1.04) / (0.13-0.04)
$ 4.62
e.
($0.40*1.04) / (0.20-0.04)
$ 2.60
3
Formula
Annual dividend
a.
$10,000,000 * 12%
$ 1,200,000
b.
$10,000,000 * 18%
$ 1,800,000
c.
$10,000,000 * 8%
$ 800,000
d.
$10,000,000 * 6%
$ 600,000
1
Formula
Price per share
a.
$0.50/0.05
$ 10.00
b.
$0.50/0.08
$ 6.25
c.
$0.50/0.10
$ 5.00
d.
$0.50/0.13
$ 3.85
e.
$0.50/0.20
$ 2.50
2
Formula
Price per share
a.
($0.40*1.04) / (0.05-0.04)
$ 41.60
b.
($0.40*1.04) / (0.08-0.04)
$ 10.40
c.
($0.40*1.04) / (0.10-0.04)
$ 6.93
d.
($0.40*1.04) / (0.13-0.04)
$ 4.62
e.
($0.40*1.04) / (0.20-0.04)
$ 2.60
3
Formula
Annual dividend
a.
$10,000,000 * 12%
$ 1,200,000
b.
$10,000,000 * 18%
$ 1,800,000
c.
$10,000,000 * 8%
$ 800,000
d.
$10,000,000 * 6%
$ 600,000
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