Exercise 43 Please use the following information for questio

Exercise 4-3 Please use the following information for questions 1-4 (be careful about rounding). Stock A pays a dividend of $3 per share next year. The constant growth rate of the dividend is 5% every year. The discount rate is 10%. 1. If you hold the stock for one year, what is the price for stock A you have to pay now (PO)? A) $60 B) $63 C) $30 D) $55 E) None of the above 2. If you hold the stock for two years, what is the price for stock A you have to pay now (PO)? A) $61 B) $62 C) $63 D) $55 E) None of the above 3. If you hold the stock for three years, what would be the price for stock A three years from now (P3)? A) $60 B) $63 C) $69 D) $55 E) None of the above 4. If you hold the stock for two years, what would be the price for stock A two years from now (P2)? A) $60 B) $63 C) $66 D) $55 E) None of the above Please use the following information for questions 5-8. Stock A pays an earnings of $5 per share in rate is 10%. year 1. The return on equity is 20%. The discount 5. If there is no plow-back, what is the stock price now (PO)? A) $40

Solution

I am going to answer the first 4 parts to the question. The first 4 parts require application of the constant Gordon growth model:

P₀ = D (1+g)/(r-g)

1B ) 3(1.05)/(0.10-0.05)= $ 63

2A) (3*1.05* 1.05 / 0.10- 0.05)= 66.15.

This would be the price at the Year 1. Now we have to discount it to year :

66.15/1.10= $ 60.13 = $ 61

3C) (3*1.05*1.05*1.05)/(0.10-0.05)=$ 69.45 =$ 69

4C) (3*1.05*1.05)/(0.10-0.05)= $ 66.15= $ 66