If the dividend grows at a steady rate, g, then the price can be written as:
Dividend Growth Model:
Po = Do x (1 + g) / (R g) or
Pt = Dt x ( 1 + g) / ( R g ) where P is the price of the stock; D is the dividend; g is the growth; R
is the required return.
Q: A stock will sell for $70 in one year and will pay $10 dividend at the end of the year. What is
the price of the stock. Assume a 25% return.
P0 price of the stock or PV; D1 is the dividend at the end of year 1; P1 is the price at the end of
year 1.
A: P0 = (D1 + P1) / (1 + R); P0 = (10 + 70) / 1.25; Price = $64
P0 = D1/(1+R)1 + D2/(1+R)2 + D3/(1+R)3 + D4/(1+R)4 +
The price of the stock is = the present value of all future dividends indefinitely so we need to
modify this equation.
Q: If growth is zero, in other words the dividend is constant at $10 and the required return is
20%. Calculate the price of the stock. P0 = D / R
A: Current price of the stock = 10/.2 = $50 per share
Q: If a dividend is currently $3 and is expected to grow 8% per year, how much will the dividend
be in 5 years.
A: 3 x (1.08)5 = $4.41
Q: If dividend growth is expected to be 5%, dividend payment is $10 at the end of this year and
the required return is 20%. Calculate the new price of the stock. P 0 = D1 / R g
A: Current price of the stock = 10 / .2 - .05 = $66.67
Q: Use the dividend growth model to calculate the price per share if D 0 = $2.30, R = 13, g = 5%.
P0 = D0 x (1 + g) / R g
A: P0 = 2.30 x 1.05 / ( .13 - .05); P 0 = $30.19
Q: Refer to the previous question. Use the dividend growth model and assuming constant
growth calculate the price of the stock at the end of year 5.
Pt = Dt x (1 + g) / (R g)
A: P5 = 2.30 x (1.05)5 / .13 - .05; P5 = 2.935 x 1.05 / .08 = 3.0822/.08 = $38.53
Q: Assume a company pays a dividend of $4 at the END of the year. D 1 = 4. Investors require a
16% return and the dividend increases by 6% every year. Based on the dividend growth model
what is the value of the stock today? What is the value of the stock in 4 years?
A: P0 = D1 / (R g). P0 = 4 / 0.16 - 0.06. P0 = $40.
Dividend in 4 years D4 = D1 x (1 + g )3. D4 = 4 x 1.063. D4 = $4.764
Price of the stock in 4 years P4 = D4 x ( 1 + g) / (R g). P4 = 4.764 x 1.06 / 0.16 - 0.06
P4 =
$50.50
Q: Assume a company is not currently paying dividends but intends on paying a dividend of
$0.50 per share in 5 years. At that time it is expected the dividend to grow by 10% annually.
The required rate of return is expected to be 20%. What is the price of the stock today?
A: P4 = D5 / (R - g);
P4 = .5 / .2 - .1;
P4 = $5. P0 = P4 / (1 + R)4;
P0 = 5 / 1.24;
P0 = $2.41
Dividend Yield = D1 / P0. The dividend growth rate (g) can be interpreted as the capital gains
yield.
P0 = D1 / (R g) OR R g = D1 / P0 OR R = (D1 / P0 )+ g
Q: A stock is selling for $20 per share. The next dividend will be $1 per share. Dividend growth
will be 10%. What is the return (R) on this stock?
A: R = Dividend yield + Capital gains yield;
R = (D1 / P0 ) + g;
R = 1 / 20 + 10%;
R = 5% + 10%;
R = 15%
Question 7. Moose Corp. pays a constant $15 dividend on its stock. The company will maintain
this dividend for the next 8 years and will then cease paying dividends forever. If the required
return on this stock is 11%, what is the current share price?
_______________________________________________________________________________________________
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_______________________________________________________________________________________________
_______________________________________________________________________________________________
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Question 8. Lacrosse, Inc. has an issue of preferred stock outstanding that pays a $7 dividend
every year, in perpetuity. If this issue currently sells for $90.21 per share, what is the required
return?
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_______________________________________________________________________________________________
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Question 11. The stock price of York Co. is $70. Investors require a 12% rate of return on similar
stocks. If the company plans to pay a dividend of $4.25 next year, what growth rate is expected
for the companys stock price?
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ACCT-702
Chapter 7 Stock Valuation
How do we value common stock? ____________________________________________________________
are one of the primary factors we look at when we attempt to value common stock. We look at
_____________________________________________, and the connection between the two. Common
stock is more difficult to value in practice than a bond because:
1. _______________________________________________________________________________________
2. _______________________________________________________________________________________
3._______________________________________________________________________________________
We determine the value or price of the stock by calculating the _________________________ of the
_____________________________________________________________.
Q: What determines the price of a stock?
A: ______________________________________________________________________________________
_________________________________________________________________________________________
P0 = D1/(1+R)1 + D2/(1+R)2 + D3/(1+R)3 + D4/(1+R)4 +
The price of the stock is = the present value of all future dividends indefinitely so we need to
modify this equation.
KEY EQUATIONS:
1. The General Case.
In general, the price today of a share of stock, P 0 is the present value of both its dividend and
price in one period for different growth:
___________________________________________________________________________________________
2. Constant Growth Case:
If the dividend is constant and equal D, then the price can be written as:
___________________________________________________________________________________________
If the dividend grows at a steady rate, g, then the price can be written as:
Dividend Growth Model:
__________________________________________________________________________________________
__________________________________________________________________________________________
3. The Required Return.
The required return can be written as: _________________________________________________________
Other Variations of the above.
D1 is the same as _________________________________________________________________________
D2, is the same as _________________________________________________________________________
P4 = D5 / R g
P0 = P 4 / ( 1 + R ) 4
P0 = D1 / (1 + R ) 1
Dividend Yield = ________________________________________________________________________
PVa = PMT; P/Yr; xP/Yr
What is the practical use of the above equations?
Compare the P0 to market value of the security and determine if the price is a
__________________________
Q: A stock will sell for $70 in one year and will pay $10 dividend at the end of the year. What is
the price of the stock. Assume a 25% return.
P0 price of the stock or PV; D1 is the dividend at the end of year 1; P1 is the price at the end of
year 1.
A: ______________________________________________________________________________
P0 = D1/(1+R)1 + D2/(1+R)2 + D3/(1+R)3 + D4/(1+R)4 +
The price of the stock is = ___________________________________________________________.
Q: If growth is zero, in other words the dividend is constant at $10 and the required return is
20%. Calculate the price of the stock.
A: Current price of the stock _________________________________________________________
Q: If a dividend is currently $3 and is expected to grow 8% per year, how much will the dividend
be in 5 years.
A: Dividend in 5 years = ______________________________________________________________
Q: If dividend growth is expected to be 5%, dividend payment is $10 at the end of this year and
the required return is 20%. Calculate the new price of the stock.
A: Current price of the stock = ________________________________________________________
Q: Use the dividend growth model to calculate the price per share if D 0 = $2.30, R = 13, g = 5%.
A: ______________________________________________________________________________
________________________________________________________________________________
Q: Use the dividend growth model and assuming constant growth calculate the price of the stock
at the end of year 5.
A: ______________________________________________________________________________
________________________________________________________________________________
Q: Assume a company pays a dividend of $4 at the END of the year. D 1 = 4. Investors require a
16% return and the dividend increases by 6% every year. Based on the dividend growth model
what is the value of the stock today? What is the value of the stock in 4 years?
A: Value of the stock today _________________________________________________________
________________________________________________________________________________
Dividend in 4 years ________________________________________________________________
________________________________________________________________________________
Price of the stock in 4 years P4 = D4 x ( 1 + g) / (R g). ____________________________________
________________________________________________________________________________
Q: Assume a company is not currently paying dividends but intends on paying a dividend of
$0.50 per share in 5 years. At that time it is expected the dividend to grow by 10% annually.
The required rate of return is expected to e 20%. What is the price of the stock today?
A: P4 = D5 / (R - g) _________________________________________________________________
________________________________________________________________________________
Dividend Yield = D1 / P0. The dividend growth rate (g) can be interpreted as the capital gains
yield.
P0 = D1 / (R g) OR R g = D1 / P0 OR R = (D1 / P0 )+ g
Q: A stock is selling for $20 per share. The next dividend will be $1 per share. Dividend growth
will be 10%. What is the return (R) on this stock?
A: R = Dividend yield + Capital gains yield; R = _________________________________________
_______________________________________________________________________________
Question 1. page 226. Money Inc., just paid a dividend of $2.50 per share on its stock. The
dividends are expected to grow at a constant rate of 5% per year, indefinitely. If investors
require an 11% return on Money stock, what is the current price? What will the price be in 3
years? In 15 years?
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Question 2. The next dividend payment by the Bank of Labrador will be $1.80 peer share. The
dividends are anticipated to maintain a 6.5% growth rate forever. If the Bank of Labrador stock
currently sells for $47.00 per share, what is the required return?
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
Question 3. For the company in the previous problem, what is the dividend yield? What is the
expected capital gains yield?
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
Question 4. Canadian Rockies Corporation will pay a $4.50 per share dividend next year. The
company pledges to increase its dividend by 4% per year indefinitely. If you require a 12% return
on your investment, how much will you pay for the companys stock today?
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
Question 5. Niagara Falls, Inc., is expected to maintain a constant 6% growth rate in its
dividends, indefinitely. If the company has a dividend yield of 4.1%, what is the required return
on the companys stock?
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________________________________
Question 8. Lacrosse, Inc., has an issue of preferred stock outstanding that pays a $7 dividend
every year, in perpetuity. If this issue currently sells for $90.21 per share, what is the required
return?
__________________________________________________________________________________
__________________________________________________________________________________
__________________________________________________________________________________