PART I JJ Companies will pay an annual dividend of $4.20 a share on its common s

Question

PART I

JJ Companies will pay an annual dividend of $4.20 a share on its common stock next year. Last week, the company paid a dividend of $4.00 a share. The company adheres to a constant rate of growth dividend policy. What will one share of this stock be worth 8 years from now if the applicable discount rate is 14 percent?

A.$68.95 B.

$81.44

C.$74.21

D.$71.16

E.$77.09

PART II

Wilton's Market just announced its next annual dividend will be $1.62 a share with future dividends increasing by 2.2 percent annually. How much will one share of this stock be worth 6 years from now if the required return is 12.5 percent?

A.$16.76

B.$17.92

C.$18.14

D.$18.32

E.$15.79

PART III

XanEx is a new firm that just paid an annual dividend of $1 a share. The firm plans to increase its dividend by 10 percent a year for the next 4 years and then decrease the growth rate to 2 percent annually. If the required rate of return is 18.25 percent, what is one share of this stock worth today?

A. $8.05

B. $8.19

C. $11.05

D. $11.19

E. $14.81

Explanation / Answer

Answer 1.

D0 = $4.00
D1 = $4.20

Let growth rate be g%

D0 * (1 + g) = D1
$4.00 * (1 + g) = $4.20
1 + g = 1.05
g = 0.05 = 5.0%

D9 = D0 * (1+g)^9
D9 = $4.00 * 1.05^9
D9 = $6.2053

Discount rate, i = 14%

P8 = D9 / (i - g)
P8 = $6.2053 / (0.14 - 0.05)
P8 = $6.2053 / 0.09
P8 = $68.95

So, stock price after 8 years is $68.95

Answer 2.

D1 = $1.62
growth rate, g = 2.2%
required return, r = 12.5%

D7 = D1 * (1 + g)^6
D7 = $1.62 * 1.022^6
D7 = $1.8460

P6 = D7 / (r - g)
P6 = $1.8460 / (0.125 - 0.022)
P6 = $1.8460 / 0.103
P6 = $17.92

So, price after 6 years is $17.92

Answer 3.

D0 = $1.00
growth rate for first 4 years is 10% and 2% after that

D1 = $1.0000 * 1.10 = $1.1000
D2 = $1.1000 * 1.10 = $1.2100
D3 = $1.2100 * 1.10 = $1.3310
D4 = $1.3310 * 1.10 = $1.4641
D5 = $1.4641 * 1.02 = $1.4934

Required return, r = 18.25%
constant growth rate, g = 2%

P4 = D5 / (r - g)
P4 = $1.4934 / (0.1825 - 0.02)
P4 = $9.1900

P0 = $1.1000/1.1825 + $1.2100/1.1825^2 + $1.3310/1.1825^3 + $1.4641/1.1825^4 + $9.1900/1.1825^4
P0 = $8.06

So, current price is $8.06

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