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Dividend Discount Model

Amazon.com has never paid a dividend, but its share price is $66 and the market value of its stock is $22 billion. Does this invalidate the dividend discount model?

2. Dividend Yield. Favored stock will pay a dividend this year of $2.40 per share. Its dividend yield is 8 percent. At what price is the stock selling?

3. Preferred Stock. Preferred Products has issued preferred stock with a $7 annual dividend that will be paid in perpetuity.

a. If the discount rate is 12 percent, at what price should the preferred sell?

b. At what price should the stock sell 1 year from now?

c. What is the dividend yield, the capital gains yield, and the expected rate of return of the stock?

4. Constant-Growth Model. Waterworks has a dividend yield of 8 percent. If its dividend is expected to grow at a constant rate of 5 percent, what must be the expected rate of return on the company s stock?

5. Dividend Discount Model. How can we say that price equals the present value of all future dividends when many actual investors may be seeking capital gains and planning to hold their shares for only a year or two? Explain.

6. Rate of Return. Steady As She Goes, Inc., will pay a year-end dividend of $2.50 per share. Investors expect the dividend to grow at a rate of 4 percent indefinitely.

a. If the stock currently sells for $25 per share, what is the expected rate of return on the stock?

b. If the expected rate of return on the stock is 16.5 percent, what is the stock price?

7. Dividend Yield. BMM Industries pays a dividend of $2 per quarter. The dividend yield on its stock is reported at 4.8 percent. What price is the stock selling at?

8. Stock Values. Integrated Potato Chips paid a $1 per share dividend yesterday. You expect the dividend to grow steadily at a rate of 4 percent per year.

a. What is the expected dividend in each of the next 3 years?

b. If the discount rate for the stock is 12 percent, at what price will the stock sell?

c. What is the expected stock price 3 years from now?

d. If you buy the stock and plan to hold it for 3 years, what payments will you receive? What

is the present value of those payments? Compare your answer to (b).

9. Constant-Growth Model. A stock sells for $40. The next dividend will be $4 per share. If the rate of return earned on reinvested funds is 15 percent and the company reinvests 40 percent of earnings in the firm, what must be the discount rate?

10. Constant-Growth Model. Gentleman Gym just paid its annual dividend of $2 per share, and it is widely expected that the dividend will increase by 5 percent per year indefinitely.

a. What price should the stock sell at? The discount rate is 15 percent.

b. How would your answer change if the discount rate were only 12 percent? Why does the answer change?

11. Constant-Growth Model. Arts and Crafts, Inc., will pay a dividend of $5 per share in 1 year. It sells at $50 a share, and firms in the same industry provide an expected rate of return of 14 percent. What must be the expected growth rate of the company s dividends?

12. Constant-Growth Model. Eastern Electric currently pays a dividend of about $1.64 per share and sells for $27 a share.

a. If investors believe the growth rate of dividends is 3 percent per year, what rate of return do they expect to earn on the stock?

b. If investors required rate of return is 10 percent, what must be the growth rate they expect of the firm?

c. If the sustainable growth rate is 5 percent, and the plowback ratio is .4, what must be the rate of return earned by the firm on its new investments?

13. Constant-Growth Model. You believe that the Non-stick Gum Factory will pay a dividend of $2 on its common stock next year. Thereafter, you expect dividends to grow at a rate of 6 percent a year in perpetuity. If you require a return of 12 percent on your investment, how much should you be prepared to pay for the stock?