4. Kinston Industries just announced that it will cut its dividend from $3.00 to
ID: 2777942 • Letter: 4
Question
4. Kinston Industries just announced that it will cut its dividend from $3.00 to $2.00 per share and use the extra funds to expand its operations. Kinston's dividends were expected to grow at a 2% rate, and its share price was $37.50. With the new expansion, Kinston dividends are expected to grow at a 5% rate. Kinston's share price after this announcement should be:
a. $20.00
b. $30.00
c. $37.50
d. $40.00
5. Which of the following statements is FALSE?
a. If the profit opportunities from having private information are large, other individuals will attempt to gain the expertise and devote the resources needed to acquire it.
b. When private information is relegated to the hands of a relatively small number of investors, these investors may be able to profit by trading on their information.
c. When a buyer seeks to buy a stock, the willingness of other parties to sell the same stock suggests that they value the stock differently.
d. Since stock markets aggregate the information and view of many different investors, we expect the stock price to react slowly to new publicly available information as the investors continue to trade until a consensus is reached as to the new value of the stock.
Chapter 9
Problems:
Use the following information to answer the question(s) below.
Company
Ticker
Price
per Share
Earnings
per Share
Book Value
per Share
Abbott Labs
ABT
54.35
3.69
13.79
Bristol-Myers-Squibb
BMY
25.45
1.93
7.33
GlaxoSmithKline
GSK
41.3
3.15
6.03
Johnson & Johnson
JNJ
62.6
4.58
18.27
Merck
MRK
36.25
3.81
10.86
Pfizer
PFE
$18.30
$1.20
8.19
1. Assuming that Novartis AG (NVS) has an EPS of $3.35, what should Novartis stock price be, based upon the average P/E ratio for its competitors?
2. Assuming that Novartis AG (NVS) has an EPS of $3.35, what is the highest expected stock price for Novartis, based upon the P/E ratios for its competitors?
Company
Ticker
Price
per Share
Earnings
per Share
Book Value
per Share
Abbott Labs
ABT
54.35
3.69
13.79
Bristol-Myers-Squibb
BMY
25.45
1.93
7.33
GlaxoSmithKline
GSK
41.3
3.15
6.03
Johnson & Johnson
JNJ
62.6
4.58
18.27
Merck
MRK
36.25
3.81
10.86
Pfizer
PFE
$18.30
$1.20
8.19
Explanation / Answer
Answer-4:
Calculation of Stock Price after Dividend announcement:
Expected dividend
$2
Expected Growth rate
5%
Required rate of return = (Current Expected Dividend / Share Price )+ Current Growth rate
10%
= (3 / 37.50 ) +2%
Expected Current Price = Expected dividend / (Required rate - Expected growth rate)
$ 40.00
= 2/ (10%-5%)
Answer-5:
Following statements are true :
a. If the profit opportunities from having private information are large, other individuals will attempt to gain the expertise and devote the resources needed to acquire it.
b. When private information is relegated to the hands of a relatively small number of investors, these investors may be able to profit by trading on their information.
c. When a buyer seeks to buy a stock, the willingness of other parties to sell the same stock suggests that they value the stock differently.
But following statement is false:
d. Since stock markets aggregate the information and view of many different investors, we expect the stock price to react slowly to new publicly available information as the investors continue to trade until a consensus is reached as to the new value of the stock.
Because even a single financial/ nonfinancial information may change the mood of the investor.
Answer-9:
Calculation of Average P/E ratio:
Company
Ticker
Price
Earnings
P/E ratio
per Share
per Share
A
B
A/B
Abbott Labs
ABT
54.35
3.69
14.73
Bristol-Myers-Squibb
BMY
25.45
1.93
13.19
GlaxoSmithKline
GSK
41.3
3.15
13.11
Johnson & Johnson
JNJ
62.6
4.58
13.67
Merck
MRK
36.25
3.81
9.51
Pfizer
PFE
18.3
1.2
15.25
Total
79.46
Average P/E ratio = Total /6
13.24
Calculation of Novartis stock price:
Novartis EPS
$ 3.35
Average P/E ratio
13.24
Novartis stock price = 3.35 *13.24
$ 44.35
Calculation of highest expected stock price for Novartis:
Novartis EPS
$ 3.35
Highest Expected P/E ratio
15.25
Novartis stock price = 3.35 *15.25
$ 51.09
Calculation of Stock Price after Dividend announcement:
Expected dividend
$2
Expected Growth rate
5%
Required rate of return = (Current Expected Dividend / Share Price )+ Current Growth rate
10%
= (3 / 37.50 ) +2%
Expected Current Price = Expected dividend / (Required rate - Expected growth rate)
$ 40.00
= 2/ (10%-5%)
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