Chapter 9

Stock Valuation
Learning Objectives
1. List and describe the four types of secondary markets.
. !"plain #hy many financial analysts treat preferred stock as a special type of bond rather
than as a true e$uity security.
%. &escribe ho# the general dividend'valuation model values a share of stock.
(. &iscuss the assumptions that are necessary to make the general dividend'valuation model
easier to use) and be able to use the model to compute the value of a firm*s stock.
+. !"plain #hy g must be less than , in the constant'gro#th dividend model.
-. !"plain ho# valuing a preferred stock #ith a stated maturity differs from valuing a
preferred stock #ith no maturity date) and be able to calculate the price of a share of
preferred stock under both conditions.
.. Chapter Outline
9.1 /he 0arket for Stocks
Equity securities are certificates of ownership of a corporation.
Households dominate the holdings of equity securities, owning more than 36 percent of
outstanding corporate equities.
A. Secondary Markets
In secondary markets, outstanding shares of stock are bought and sold among investors.
n active secondary market enables firms to sell their new debt or equity issues at a lower
funding cost than firms selling similar securities that have no secondary market.
B. Secondary Markets and Their Efficiency
In the !nited "tates, most secondary market transactions are conducted on one of the
many stock e#changes.
In terms of total volume of activity and total capitali$ation of the firms listed, the
%&"E is the largest in the world and %"'( is the second largest.
In terms of the number of companies listed and shares traded on a daily basis,
%"'( is larger than the %&"E.
)irms listed on the %&"E tend to be, on average, larger in si$e and their shares
trade more frequently than firms whose securities trade on %"'(.
*here are four types of secondary markets, and each type differs according to the amount
of price information available to investors, which in turn, affects the efficiency of the
market.
1. &irect Search
*he secondary markets farthest from our ideal of complete price information are those
in which buyer and seller must seek each other out directly.
It is too costly to perform a thorough search among all possible partners done to locate
the best price.
"ecurities that sell in direct search markets are usually bought and sold so infrequently
that no third party, such as a broker or dealer, finds it profitable to serve the market.
*he sales of common stock of small private companies and private placement
transactions are good e#amples of direct search markets.
. 1roker
+rokers bring buyers and sellers together to earn a fee, called a commission.
+rokers, e#tensive contacts provide them with a pool of price information that
individual investors could not economically duplicate themselves.
+y charging a commission fee less than the cost of direct search, brokers give
investors an incentive to make use of the information by hiring them as brokers.
%. &ealer
-arket efficiency is improved if there is someone in the marketplace to provide
continuous bidding .selling or buying/ for the security.
'ealers provide this service by holding inventories of securities, which they own, then
buying and selling from the inventory to earn a profit.
'ealers earn their profits from the spread on the securities they trade0the difference
between their bid price .the price at which they buy/ and their offer price .the price at
which they sell/.
*he advantage of a dealer over a brokered market is that brokers cannot guarantee that
an order will be e#ecuted promptly, while dealers can because they have an inventory
of securities.
dealer market eliminates the need for a time1consuming search for a fair deal by
buying and selling immediately from the dealers, inventory of securities.
%"'( is the best1known e#ample of a dealer market.
Electronic communications network .E2%/ systems provide additional price
information to investors and increase marketability and competition, which should
improve %"'( efficiency.
(. 2uction
In an auction market, buyers and sellers confront each other directly and bargain over
price.
*he %ew &ork "tock E#change is the best1known e#ample of an auction market.
In the %&"E the auction for a security takes place at a specific location on the floor of
the e#change, called a post.
*he auctioneer in this case is the specialist who is designated by the e#change to
represent orders placed by public customers.
C. Reading the Stock Market Listings
*he Wall Street Journal, the New York Times, and other newspapers in
large metropolitan areas provide stock listings for the major stock
exchanges, such as the NYSE and the relevant regional exchanges.
!"hibit 9.1 shows a section of the listing in the Wall Street Journal
for the NYSE.
D. Types of Equity Securities
*he two types of equity securities are common stock and preferred stock.
Common stock represents the basic ownership claim in a corporation.
3ne of the rights of the owners is to vote on all important matters that affect the
life of the company, such as electing the board of directors or voting on a proposed
merger or acquisition.
3wners of common stock are not guaranteed any dividend payments and have the
lowest1priority claim on the firm,s assets in the event of bankruptcy.
4egally, common stockholders en5oy limited liability.
2ommon stocks are perpetuities in the sense that they have no maturity.
3referred stock also represents ownership interest in the corporation, but preferred stock
receives preferential treatment over common stock in certain matters.
If a preferred dividend payment is not paid due to the firm,s financial condition,
the firm is not in default technically. However, the market reacts as if the failure to
make the dividend payment is a default and punishes the stock accordingly.
6referred stock owners are given priority treatment over common stock with
respect to dividends payments and the claims against the firm,s assets in the event
of bankruptcy or liquidation.
'ividends payments are paid with after1ta# dollars sub5ect to ta#ation.
Even though preferred stock is equity, the owners have no voting privileges.
6referred stocks are legally classified as perpetuities because they have no
maturity. However, most preferred stocks are not true perpetuities because the
shares contain a call provision and the share contract often requires management
to retire a certain percent of the stock annually until the entire issue is retired.
E. Preferred Stock De!t or Equity"
4egally, preferred stock is equity.
4ike the dividends on common stock, preferred stock dividends are ta#able.
strong case can be made that preferred stock is really a special type of bond.
)irst, regular preferred stock confers no voting powers.
"econd, preferred stockholders receive a fi#ed dividend, regardless of the firm,s
earnings, and if the firm is liquidated, they receive a stated value .usually par/ and
not the residual value.
*hird, preferred stocks often have 7credit8 ratings that are similar to those issued
to bonds.
)ourth, preferred stock is sometimes convertible into common stock.
)inally, most preferred stock issues today are not true perpetuities. Increasingly,
preferred stock issues have the sinking fund feature, which require mandatory
annual retirement schedules.
9. Common Stock Valuation
9aluation of common and preferred stock is done by using the same basic methodology that
was discussed for bond valuations in 2hapter 6.
1. Estimate the future cash flows.
. 'etermine the required rate of return, or discount rate, which depends on the riskiness of
the future cash flows.
%. 2ompute the present value of the future cash flows to determine what the asset is
worth.
pplying the valuation procedure to common stocks is more difficult than applying it to
bonds for various reasons.
)irst, in contrast to coupon payments on bonds, the si$e and timing of the dividend
cash flows are less certain.
"econd, common stocks are true perpetuities in that they have no final maturity date.
)inally, unlike the rate of return, or yield, on bonds, the rate of return on common
stock is not directly observable.
A. A #ne$Period Mode%
one-period model provides an estimate of the market price.
he value of an asset is the present value of its future cash flows!
the future dividend and the end-of-period stock price.
B. A T&o$Period Mode%
*his model can be viewed as two one1period models strung together.
C. A Perpetuity Mode%
series of one1period stock pricing models is strung together to arrive at a stock
perpetuity model.
*hough theoreticall" sound, this model is not practical to appl"
#ecause the num#er of dividends could #e infinite.
D. The 'enera% Di(idend )a%uation Mode%
Equation :.; is a general e#pression for the value of a share of stock. It says that the
price of a share of stock is the present value of all expected future dividends.
infinity
infinity
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*he formula does not assume any specific pattern for future cash dividends, such
as a constant-growth rate.
It does not make any assumption about when the share of stock is going to be sold
in the future.
)inally, the model says that to compute a stock,s current value, we need to forecast
an infinite number of dividends.
Equation :.; implies that the underlying value of a share of stock is determined by the
market,s e#pectations of future cash flows that the firm can generate.
In efficient markets, stock prices change constantl" as new
information #ecomes availa#le and is discounted into the firm$s
market price.
)or publicly traded companies, there is a constant stream of information about the firm
that reaches the market, with some having an impact on the stock price while other
information has no effect.
E. The 'ro&th Stock Pricing Parado*
Growth stocks are typically defined as the stocks of companies whose earnings are
growing at above1average rates and are e#pected to continue to do so for some time.
%ast growing companies t"picall" pa" no dividends on their stock
during their growth phase #ecause management #elieves that the
compan" has a num#er of high-return investment opportunities and that
#oth the compan" and its investors will #e #etter off if earnings are
reinvested.
Equation :.; predicts and common sense says that if you own stock in a company that
will never pay you any cash, the market value of those shares of stock are worth
absolutely nothing.
&n realit", these firms will eventuall" pa" out dividends in the
distant future.
If the internal investments succeed, the stock,s price should go up significantly, and
investors can sell their stock at a price much higher than what they paid.
9.% Stock Valuation4 Some Simplifying 2ssumptions
*o make Equation :.; more applicable, some simplif"ing assumptions a#out
the pattern of dividends are necessar".
*hree different assumptions can cover most growth patterns.
'ividend payments remain constant over timeA that is, they have a growth rate of
$ero.
'ividends have a constant-growth rate.
'ividends have a mi#ed growth rate patternA that is, dividends have one payment
pattern then switch to another.
A. +ero$'ro&th Di(idend Mode%
*he dividend pa"ment pattern remains constant over time'
(
)
* (
+
* (
,
* . . . * (
-
In this case the dividend1discount model .Equation :.;/ becomesB
. ..........
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6
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*his cash flow pattern essentially describes a perpetuity with a constant cash flow. In
2hapter 6 we developed the present value of a perpetuity with a constant cash flow
as 2)Ci, where 2) is the constant cash flow and i is the interest rate. "imilarly,
Equation :.> gives the valuation model for a $ero1growth stock.
@
'
6
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!"ampleB "uppose a stock is e#pected to pay a D> dividend each period, forever, and the
required return is ;?E. Fhat is the stock worthG
6
?
H > C .;? H D>?
@ H ;>E
6
?
H > C .;> H D;6.6I
Jesto, Inc., has an issue of preferred stock outstanding that pays a D< dividend every year, in perpetuity.
If this issue currently sells for DK=.;> per share, what is the required returnG
R H ' C 6
?
R H D< C DK=.;> H .?<:= H <.:=E
B. Constant$'ro&th Di(idend Mode%
2ash dividends do not remain constant but instead grow at some average rate g from
one period to the next forever.
2onstant dividend growth is an appropriate assumption for mature companies with a
history of stable growth.
Fhile an infinite hori$on is still hard to comprehend, far1distant dividends have a small
present value and contribute very little to the price of the stock.
'eriving the constant1growth dividend model is fairly straightforward. )irst, we need
to build a model to compute the value of dividend payments for any time period.
*he constant1growth dividend model is easy to do because it is 5ust an application of
Equation 6.6 from 2hapter 6.
@ecall that the equation for a growing perpetuity in 2hapter 6 is given by Equation 6.6B
69
-
* .%
)
/0i 1 g2
In other words, the constant1growth dividend model tells us that the current price of a
share of stock is the ne#t period dividend divided by the difference between the
discount rate and the dividend growth rate.
Equation :.= shows how to value a constant-growth stock'
/ @ .
'
6
;
?
g

"ince the dividend is e#pected to grow at a steady rate, then we have replaced the problem of
forecasting an infinite number of future dividends with the problem of coming up with a single
growth rate, a considerable simplification. In this case, if we take D
?
to be the dividend 5ust paid
and g to be the constant growth rate, the value of a share of stock can be written asB
s long as the growth rate, g, is less than the discount rate, R, the present value of this series of
cash flows can be written very simply asB
*his dividend gro#th model) also referred to as the constant gro#th model) dividend discount
model) or the 5ordon model) is used to find the value of a stock whose dividend is e#pected to
grow at a constant rate .g/ forever. *he other basic assumption for the model to hold requires R L
g. *he value obtained, P
0
, is the 7theoretical8 or 7intrinsic8 value of the stock. Fe would then
compare this value to the actual price of the stock observed in the market.
Fe can actually use the dividend growth model to get the stock price at any point in time, not 5ust
today. In general, the price of the stock as of time t isB
+anya, Inc., 5ust paid a dividend of D>.>? per share on its stock. *he dividends are
e#pected to grow at a constant rate of = percent per year, indefinitely. If investors
require an ;; percent return on +anya stock, what is the current priceG Fhat will the
price be in three yearsG In ;< yearsG
*he constant dividend growth model isB
6
t
H '
t
M .; N g/ C .R O g/
"o, the price of the stock today isB
6
?
H '
?

.; N g/ C .R O g/
6
?
H D>.>? .;.?=/ C ..;; O .?=/
6
?
H D3>.6:
*he dividend at year = is the dividend today times the )9I) for the growth rate
in dividends and four years, soB
6
3
H '
3

.; N g/ C .R O g/
6
3
H '
?

.; N g/
=

C .R O g/
6
3
H D>.>? .;.?=/
=

C ..;; O .?=/
6
3
H D36.II
Fe can do the same thing to find the dividend in &ear ;6, which gives us the
price in &ear ;<, soB
6
;<
H '
;<

.; N g/ C .R O g/
6
;<
H '
?

.; N g/
;6

C .R O g/
6
;<
H D>.>? .;.?=/
;6

C ..;; O .?=/
6
;<
H D<K.KI
*here is another feature of the constant dividend growth modelB *he stock price
grows at the dividend growth rate. "o, if we know the stock price today, we can
find the future value for any time in the future we want to calculate the stock
price. In this problem, we want to know the stock price in three years, and we
have already calculated the stock price today. *he stock price in three years will
beB
6
3
H 6
?
.; N g/
3

6
3
H D3>.6:.; N .?=/
3

6
3
H D36.II
nd the stock price in ;< years will beB
6
;<
H 6
?
.; N g/
;<

6
;<
H D3>.6:.; N .?=/
;<

6
;<
H D<K.KI
ntiques P@, !s is a mature manufacturing firm. *he company 5ust paid a DI
dividend, but management e#pects to reduce the payout by < percent per year,
indefinitely. If you require a ;? percent return on this stock, what will you pay for a
share todayG
*he constant growth model can be applied even if the dividends are declining by a
constant percentage, 5ust make sure to recogni$e the negative growth. "o, the price
of the stock today will beB
6
?
H '
?
.; N g/ C .R O g/
6
?
H DI.??.; O .?</ C Q..;? O .O.?</R
6
?
H D6.6< C .;<
6
?
H D==.33
*he ne#t dividend payment by 2arroll, Inc., will be D;.:? per share. *he dividends
are anticipated to maintain a <.< percent growth rate, forever. If the stock currently
sells for D=I.?? per share, what is the required returnG
R H .'
;
C 6
?
/ N g
R H .D;.:? C D=I.??/ N .?<<
R H .?:<= or :.<=E
+arnard 2orp. will pay a dividend of D3.?< ne#t year. *he company has stated that it
will maintain a constant growth rate of < percent a year forever. If you want a ;<
percent rate of return, how much will you pay for the stockG Fhat if you want a ;?
percent rate of returnG Fhat does this tell you about the relationship between the
required return and the stock priceG
Here, we need to value a stock with two different required returns. !sing the
constant growth model and a required return of ;< percent, the stock price today isB
6
?
H '
;
C .R O g/
6
?
H D3.?< C ..;< O .?</
6
?
H D3?.<?
nd the stock price today with a ;? percent return will beB
6
?
H '
;
C .R O g/
6
?
H D3.?< C ..;? O .?</
6
?
H D6;.??
ll else held constant, a higher required return means that the stock will sell for a
lower price. lso, notice that the stock price is very sensitive to the required return.
In this case, the required return fell by ;C3 but the stock price doubled.
67o# can g ever be assumed to be constant89 *he answer lies in the competitive equilibrium
model of classical macroeconomics. "ince g represents not only the growth rate in dividends but
also in earnings and sales, assuming no change in the firm,s cost structure, we are simply
assuming that the product market the firm operates in 7settles down8 to a steady state in which
competing firms earn sufficient returns to remain in business, but not large enough to attract
outside capital. )rom a more practical standpoint, firms will often attempt to manage their
dividend policy so that there is a reasonably constant growth in dividends.
6:hy do #e assume that R , g89 t least two answers are possible. )irst, @ may be less than g
in the short1run. *he supernormal growth problem is an e#ample of this situation. "econd, in
equilibrium, high returns on investment will attract capital, which, in the absence of
technological change, will ensure that in succeeding periods, higher returns cannot be earned
without taking greater risk. +ut taking greater risk will increase R, so g cannot be increased
without raising R.
C. Co-puting .uture Stock Prices
*he constant1growth dividend model .Equation :.=/ can be modified to determine the
value, or price, of a share of stock at any point in time.
*his results in Equation :.<, which shows that the price of a share of stock
at time t is as follows'
;
'
6 H
.@1 /
t
t
g
+
D. The Re%ationship !et&een R and g
*he constant1growth dividend model yields solutions that are invalid anytime the
dividend growth rate equals or e#ceeds the discount rate .g 3 42.
If g * 4, the value of the denominator is 5ero and the value of the
stock is infinite, which makes no sense.
If g 6 4, the present value of the dividend gets #igger and #igger
rather than smaller and smaller, as it should. his implies that a
firm that is growing at a ver" fast rate does so forever.
E. Supernor-a% 'ro&th Di(idend Mode%
'uring the early part of their lives, very successful firms e#perience a supernormal rate
of growth in earnings.
*o value a share of stock for a firm with supernormal dividend growth patterns, we can
apply Equation :.;, our general dividend model, and Equation :.<, which gives us the
price of a share of stock with constant dividend growth at any point in time.
*hus, our valuation model is 0E7uation 8.62'
6
9
* :; 0<ixed dividend growth2 = :; 0.onstant dividend growth2
t
t
t
t
>
> ;
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6
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*he main reason to consider this case is to allow for 7supernormal8 growth rates over some finite
length of time. s we know, the growth rate cannot e#ceed the required return indefinitely, but it
certainly could do so for some number of years. *o avoid the problem of having to forecast and
discount an infinite number of dividends, we will require that the dividends start growing at a
constant rate sometime in the future.
2ommon "tock 9aluation under "upernormal Jrowth .two1stage growth/
[ ]
s
s
s
%
n
n
%
s ?
%
s
s
s ?
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+ +
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H Intrinsic or theoretical value of the stock
'
?
H *he dollar amount of the last actual dividend on the stock
@ H @equired rate of return on the stock
g
n
H E#pected constant growth rate of the dividends on the stock
g
s
H E#pected supernormal growth rate of the dividends on the stock
%
s
H %umber of years of initial .supernormal/ growth
*he Jlass 2orp. is growing quickly. 'ividends are e#pected to grow at a >? percent rate for the
ne#t three years, with the growth rate falling off to a constant 6 percent thereafter. If the required
return is ;3 percent and the company 5ust paid a D3.?< dividend, what is the current share priceG
Fith supernormal dividends, we find the price of the stock when the dividends level off at a
constant growth rate, and then find the present value of the future stock price, plus the present
value of all dividends during the supernormal growth period. *he stock begins constant growth
after the third dividend is paid, so we can find the price of the stock in &ear 3, when the constant
dividend growth begins asB
6
3
H '
3
.; N g/ C .R O g/
6
3
H '
?
.; N g
1
/
3
.; N g
2
/ C .R O g/
6
3
H D3.?<.;.>?/
3
.;.?6/ C ..;3 O .?6/
6
3
H DI:.K;
*he price of the stock today is the present value of the first three dividends, plus the present
value of the &ear 3 stock price. *he price of the stock today will beB
6
?
H D3.?<.;.>?/ C ;.;3 N D3.?<.;.>?/
>
C ;.;3
>
N D3.?<.;.>?/
3
C ;.;3
3
N DI:.K; C ;.;3
3
H D6<.6=
lternatively, using the equation above,
[ ]
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n
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3
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.;.;3/
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.;.?6/ / D3.?<.;.>?
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;
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/ D3.?<.;.>?
6

+
1
1
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6
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H 1<>.>K<I.1.;:I<:?6K/ N DI:.K?K:..6:3?</
6
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H D;?.33;;I N D<<.3;;<K H D6<.6=
2omponents of the @equired @eturn
@earrange 6
?
H '
;
C .@ O g/ to find @B
@ H .'
;
C 6
?
/ N g
'
;
C 6
?
H 'ividend yield
g H 2apital gains yield
@ H dividend yield N capital gains yield
*he ne#t dividend payment by 2arroll, Inc., will be D;.:? per share. *he dividends are
anticipated to maintain a <.< percent growth rate, forever. If the stock currently sells for D=I.??
per share, what is the dividend yieldG Fhat is the e#pected capital gains yieldG
*he dividend yield is the dividend ne#t year divided by the current price, so the dividend yield isB
'ividend yield H '
;
C 6
?

'ividend yield H D;.:? C D=I.??
'ividend yield H .?=?= or =.?=E
*he capital gains yield, or percentage increase in the stock price, is the same as the dividend
growth rate, soB
2apital gains yield H <.<E
*he total .e#pected/ return on the stockB
@ H '
;
C 6
?
N g H =.?=E N <.<?E H :.<=E
'iamond 2orporation will pay a D3.I< per share dividend ne#t year. *he company pledges to
increase its dividend by <.< percent per year, indefinitely. If you require a ;> percent return on
your investment, how much will you pay for the companySs stock todayG
'
;
H 3.I<, g H <.<?E, @ H ;>E
6
?
H D3.I< C ..;> 1 .?<</ H D3.I< C .?6< H D<I.6:
-ergerG
&ou assume that if you merge, g will equal KE and that @ will equal ;<E.
6
?
H D3.I< C ..;< 1 .?K/ H D<3.<I
'on,t merge, since price of stock goes down.
D<I.6: H D3.I< C ..;< O g/
K.6<3< O <I.6:g H 3.I<
=.:?3< H <I.6:g
g H =.:?3< C <I.6: H .?K<? H K.<?E .-erge if you e#pect a growth rate L K.<?E/
9.( Valuing 3referred Stock
In computing the value of preferred stock, one needs to know whether the preferred
stock has an effective >maturit"? #ecause of a sinking fund option or call
option.
*he most significant difference between preferred stock with a fi#ed maturity and a bond is
the risk of default.
"ince preferred stock dividends are declared #" the #oard of directors,
failure to pa" dividends does not result in default.
*he failure to pa" a preferred stock dividend as promised is a serious
financial #reach and signals to the market that the firm is in serious
financial difficult".
A. Preferred Stock &ith a .i*ed Maturity
Fe can use the bond valuation model developed in 2hapter K to determine its price, or
value.
Equation K.> can be restated as the price of a share of preferred stock .6"
?
2'
:referred stock price * :; 0(ividend pa"ments2 = :; 0:ar value2
( )
mn
mn mn
m) i
m
m) i
m
m) i
m
m) i
m
+
+
+ +
+
+
+
+
+

; .
6 '
; .
'
; .
'
; .
' D
6"
3
3
>
>
;
;
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;9.<=
"ince most preferred stock make quarterly dividend payments, m equals =.
B. Perpetua% Preferred Stock
"ome preferred stock issues have no maturity.
'ividends are constant over time .g H ?/.
)i#ed dividend payments go on forever.
Fe can use Equation :.> to value such preferred stock issues.
@
'
6
?

Chapter 9 Sample >uestions
0ultiple Choice
Identify the choice that best competes the statement or answers the !"estion.
;. 3V of dividends4 2orte$, Inc., is e#pecting to pay out a dividend of D>.<? ne#t year. fter that it e#pects
its dividend to grow at I percent for the ne#t four years. Fhat is the present value of dividends over the
ne#t five1year period if the required rate of return is ;? percentG
a. D;?.I<
b. D:.K?
c. D;;.KK
d. D;;.<?
>. ?ero gro#th4 Tinhua -anufacturing 2ompany has been generating stable revenues but sees no growth
in it for the foreseeable future. *he companySs last dividend was D3.><, and it is unlikely to change the
amount paid out. If the required rate of return is ;> percent, what is the stock worth todayG
a. D3:.??
b. D3.6:
c. D>I.?K
d. D>;.>3
3. Constant gro#th4 &ou are interested in investing in a company that e#pects to grow steadily at an
annual rate of 6 percent for the foreseeable future. *he firm paid a dividend of D>.3? last year. If your
required rate of return is ;? percent, what is the most you would be willing to pay for this stockG .@ound
to the nearest dollar./
a. D<K
b. D6;
c. D>3
d. D>=
=. Constant gro#th4 @yder "upplies has its stock currently selling at D63.><. *he company is e#pected to
grow at a constant rate of I percent. If the appropriate discount rate is ;I percent, what is the e#pected
dividend, a year from nowG
a. D=.=3
b. D3.><
c. D;?.I<
d. D6.33
<. Constant gro#th4 6rior, Inc., is e#pected to grow at a constant rate of : percent. If the companySs ne#t
dividend is D>.I< and its current price is D3I.3<, what is the required rate of return on this stockG .@ound
to the nearest percent./
a. ;6E
b. ;IE
c. >?E
d. >;E
6. 3referred stock valuation4 5a# 2ompany has issued perpetual preferred stock with a par of D;?? and a
dividend of <.< percent. If the required rate of return is I.I< percent, what is the stockSs current market
priceG
a. D;>.:?
b. DI?.:I
c. D<3.>I
d. D6>.;=
I. 3referred stock valuation4 *he 2olumbia 2onsumer 6roducts 2o. has issued perpetual preferred stock
with a D;?? par value. *he firm pays a quarterly dividend of D>.6? on this stock. Fhat is the current price
of this preferred stock given a required rate of return of ;>.< percentG
a. D=I.><
b. DK?.??
c. D>?.K?
d. DK3.>?
K. @onconstant gro#th4 Jrant, Inc. is a fast growth stock and e#pects to grow at a rate of >< percent for
the ne#t four years. It then will settle to a constant1growth rate of ;? percent. *he first dividend will be
paid out in year 3 and will be equal to D<.??. If the required rate of return is ;K percent, what is the
current price of the stockG
a. DK<.:=
b. D:I.;:
c. D<?.<:
d. D6<.6K
Chapter 9 Sample >uestions
2ns#er Section
0AL/.3L! C7O.C!
;. %"B
4earning 3b5ectiveB 43 =
4evel of 'ifficultyB -edium
)eedbackB E#pected dividends for 2orte$, Inc., and their present valueB
'
>
H '
;
.; N g/ H D>.<?.; N ?.?I/ H D>.6I<
'
3
H '
>
.; N g/ H D>.6I<.;.?I/ H D>.K6>
'
=
H '
3
.; N g/ H D>.K6>.;.?I/ H D3.?63
'
<
H '
=
.; N g/ H D3.?63.;.?I/ H D3.>II
6resent value of the dividends H 69.'
;
/ N 69.'
>
/ N 69.'
3
/ N 69.'
=
/ N 69.'
<
/
6*"B ;
>. %"B 2
4earning 3b5ectiveB 43 =
4evel of 'ifficultyB -edium
)eedbackB '
?
H D3.><A g H ?A @ H ;>E
6*"B ;
3. %"B +
4earning 3b5ectiveB 43 =
4evel of 'ifficultyB -edium
)eedbackB
'
?
H D>.3?A g H 6EA
6*"B ;
6repared by Uim Veys >3
=. %"B '
4earning 3b5ectiveB 43 =
4evel of 'ifficultyB Hard
)eedbackB
6
?
H D63.><A g H IEA
6*"B ;
<. %"B +
4earning 3b5ectiveB 43 =
4evel of 'ifficultyB -edium
)eedbackB '
;
H D>.I<A 6
?
H D3I.3<A g H :E
6*"B ;
6. %"B +
4earning 3b5ectiveB 43 6
4evel of 'ifficultyB -edium
)eedbackB ' H <.<E .D;??/ H D<.<?A @ H I.I<E
6*"B ;
6repared by Uim Veys >=
I. %"B '
4earning 3b5ectiveB 43 6
4evel of 'ifficultyB Hard
)eedbackB (uarterly dividend H D>.6?
@equired rate of return H @ H ;>.<E
6*"B ;
K. %"B 2
4earning 3b5ectiveB 43 =
4evel of 'ifficultyB Hard
)eedbackB g
;1=
H ><EA g H ;?EA '
3
H D<.??A @ H ;KE
'
=
H '
3
.;.></ H D<.??.;.></ H D6.><A '
<
H D6.><.;.;?/ HD6.KI<
6*"B ;
6repared by Uim Veys ><