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Examples

Examples. Example A: …. Question : Suppose Blue Skies stock is selling for $75 a share ( P0 = $75). Investors expect a $3 cash dividend over the next year (DIV1 = $3). They also expect the stock to sell for $81 a year hence ( P1 = $81). Then the expected return to stockholders is …. Examples.

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Examples

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  1. Examples Example A: … • Question: Suppose Blue Skies stock is selling for $75 a share (P0 = $75). Investors expect a $3 cash dividend over the next year (DIV1 = $3). They also expect the stock to sell for $81 a year hence (P1 = $81). Then the expected return to stockholders is …

  2. Examples Example A: … • Question: Suppose Blue Skies stock is selling for $75 a share (P0 = $75). Investors expect a $3 cash dividend over the next year (DIV1 = $3). They also expect the stock to sell for $81 a year hence (P1 = $81). • Answer: 12 percent

  3. Examples Example B: … • Question: Assume a dividend has just been paid. The next dividend, to be paid in a year, is forecast at DIV1 = $3, the growth rate of dividends is g = 8% , and the discount rate is r = 12%. The stock value is… • Answer:

  4. Examples Example B: … • Question: Assume a dividend has just been paid. The next dividend, to be paid in a year, is forecast at DIV1 = $3, the growth rate of dividends is g = 8% , and the discount rate is r = 12%. The stock value is… • Answer: $ 75

  5. Examples Example C: … • Question: Better Mousetraps has come out with an improved product, and the world is beating a path to its door. As a result, the firm projects growth of 20 percent per year for 4 years. By then, other firms will have copycat technology, competition will drive down profit margins, and the sustainable growth rate will fall to 5 percent. The most recent annual dividend was DIV0 = $1.00 per share. • a. What are the expected values of DIV1, DIV2, DIV3, and DIV4?; b. What is the expected stock price 4 years from now? The discount rate is 10 percent; c. What is the stock price today?; d. Find the dividend yield, DIV1/P0.; e. What will next year’s stock price, P1, be?; f. What is the expected rate of return to an investor who buys the stock now and sells it in 1 year? 1

  6. Examples Example D: … • Question: • Gentleman Gym just paid its annual dividend of $2 per share, and it is widely expected that the dividend will increase by 5 percent per year indefinitely. • a. What price should the stock sell at? The discount rate is 15 percent. • b. How would your answer change if the discount rate were only 12 percent? Why does the answer change?

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