Finance Management Solutions
Finance Management Solutions
PREFERRED STOCK VALUATION Ezzell Corporation issued perpetual preferred stock with
a 10% annual dividend. The stock currently yields 8%, and its par value is $100.
a. What is the stocks value?
b. Suppose interest rates rise and pull the preferred stocks yield up to 12%. What is its
new market value?
Vp=D/Rp $ 125.00
b. Suppose interest rates rise and pull the preferred stocks yield up to 12%. What is its
D 10
Rp 12
Vp $ 83.33
The New market value of the stock is $83.33
PREFERRED STOCK RETURNS Bruner Aeronautics has perpetual preferred stock outstanding
with a par value of $100. The stock pays a quarterly dividend of $2, and its current
price is $80.
a. What is its nominal annual rate of return?
b. What is its effective annual rate of return?
Vp=D/Rp 0.1
10%
EAR (1+Rnom/4)^4-1
10.38%
VALUATION OF A CONSTANT GROWTH STOCK A stock is expected to pay a dividend of
$0.50 at the end of the year (that is, D1 0.50), and it should continue to grow at a constant rate
of 7% a year. If its required return is 12%, what is the stocks expected price 4 years from today?
D1 0.5
G 7%
Rs 12% D1 D2 D3 D4 D5
1 2 3 4 5
Stock Price 4 years from now 0.5000 0.5350 0.5725 0.6125 0.6554
P4=D5/(Rs-G)
P4 ?
D5 0.6554
Rs 0.12
G 0.07
P4 $ 13.11
PV ?
Rs 15%
1 2 3 4 5 6
D1 D2 D3 D4 D5 D6
0 0 1 1.5 2.25 2.43
PV ($0.66)
($0.86)
18.47 2.43
$19.99 0.07
P5 37.14429
($18.47)
The Value of Stock is $19.99
4.658 66.54286
($46.12)
NONCONSTANT GROWTH Mitts Cosmetics Co.s stock price is $58.88, and it recently paid
a $2.00 dividend. This dividend is expected to grow by 25% for the next 3 years, then grow
forever at a constant rate, g; and rs 12%. At what constant rate is the stock expected to
grow after Year 3?
PV 58.88
D 2
G 25%
Rs 12 d d1 d2 d3 d4
2 2.5 3.125 3.90625
($2.23) ($2.49) ($2.78) ($7.50)
PV 58.88
Remaing PV $51.38 ($72.19)
FV of Remaing Div 72.19
Po3 d3(1+g)/(rs-g)
72.19 3.91+3.91g/(0.12-g)
8.6628 72.19g
8.6628-72.19g == 3.91+3.91g
4.7528 76.1
6.25%
g 20
gn -6%
r 10%
d0 d1 d2 d3 d4 d5
1.6 1.92 2.304 2.44224 2.588774 2.744101
19.2
a. If D0 $1.60 and rs 10%, what is TTCs stock worth today? What are its expected
dividend and capital gains yields at this time, that is, during Year 1?
P0=d1/(rs-g) 19.2
b. Now assume that TTCs period of supernormal growth is to last for 5 years rather than
2 years. How would this affect the price, dividend yield, and capital gains yield?
Answer in words only.
c. What will TTCs dividend and capital gains yields be once its period of supernormal
growth ends? (Hint: These values will be the same regardless of whether you examine
the case of 2 or 5 years of supernormal growth; the calculations are very easy.)
d. Of what interest to investors is the changing relationship between dividend and capital
gains yields over time?