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Foundations Of Financial Management
Found in: Page 326
Foundations Of Financial Management

Foundations Of Financial Management

Book edition 16th
Author(s) Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen
Pages 768 pages
ISBN 9781259277160

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Short Answer

Question: Beasley Ball Bearings paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 2 percent over the next four years. The required rate of return is 15 percent (this will also serve as the discount rate in this problem). Round all values to three places to the right of the decimal point where appropriate.

a. Compute the anticipated value of the dividends for the next four years. That is, compute D1, D2, D3, and D4; for example, D1 is $4.08 ($4 3 1.02).

b. Discount each of these dividends back to present at a discount rate of 15 percent and then sum them.

c. Compute the price of the stock at the end of the fourth year (P4). P4 5 D5 ______ Ke 2 g (D5 is equal to D4 times 1.02.)

d. After you have computed P4, discount it back to the present at a discount rate of 15 percent for four years.

e. Add together the answers in part b and part d to get P0, the current value of the stock. This answer represents the present value of the four periods ofdividends, plus the present value of the price of the stock after four periods (which in turn represents the value of all future dividends).

f. Use Formula 10-8 to show that it will provide approximately the same answer as part e. P0 5 D1 ______ Ke 2 g For Formula 10-8, use D1 5 $4.08, Ke 5 15 percent, and g 5 2 percent. (The slight difference between the answers to part e and part f is due to rounding.)

g. If current EPS were equal to $4.98 and the P/E ratio is 1.2 times higher than the industry average of 6, what would the stock price be?

h. By what dollar amount is the stock price in part g different from the stock price in part f?

i. In regard to the stock price in part f, indicate which direction it would move if (1) D1 increases, (2) Ke increases, and (3) g increases

Answer

  1. The D1 is $4.08, D2 is $4.162, D3 is $4.245 and D4 is $4.330.
  2. The total PV of dividends is $11.96.
  3. The price of the stock is $33.97.
  4. The Present Value of the stock price is $19.43.
  5. The current value of the stock is $31.39
  6. The price of the stock using EPS and P/E is $35.86.
  7. The difference in the price of the stock is $4.47.
  8. (1) Stock price increases
  1. Stock price decreases
  2. Stock price increases.
See the step by step solution

Step by Step Solution

Step 1 Calculation of anticipated dividend for the next three years (a)

Step 2 Computation of total present value (b)

Step 3: Computation of the price of the stock (c)

Step 4: Computation of present value of P4 (d)

Step 5: Computation of current value of stock (e)

Step 6: Computation of current value of stock (f)

Step 7: Computation of price using EPS and P/E (g)

Step 8: Computation of difference in stock price (h)

Step 9: Changes in stock price (i)

  1. If D1 Increases then stock price will also increase
  2. If Ke Increases the stock price will decrease
  3. If g increases, then stock prices will also increase

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