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Chapter 10 Answers

Question Answers

10-1 D1 = $1.3250.

D2 =$1.4045

D3 =$1.4888D4 =$1.5483

D5 =$1.6103

10-2 $22.50

10-3 $9.17

10-4 12.35%

10-5 a) The terminal, or horizon, date is the date when the growth rate becomesconstant. This occurs at the end of Year 2.

b) $31.29c) $27.69

10-6 Each share of common stock is worth $48.33

10-7 10%10-8 a) 13.33%

b) 10.0%c) 8.0%d) 5.71%

10-9 a) $125b) $83.33

10-10 a) 10%b) 10.3813%

10-11 $25.64

10-12 $13.11

10-13 a) 1) $9.502) $13.33

3)$21.00

4) $44.00

b) 1) Undefined2) -$48, which is nonsense

These results show that the formula does not make sense if the required

rate of return is equal to or less than the expected growth rate.

c) No, the results of Part b show this. It is not reasonable for a firm to growindefinitely at a rate higher than its required return. Such a stock, in

theory, would become so large that it would eventually overtake the

whole economy

10-14 $27.2210-15 $23.77

10-16 a) $713.33 millionb) $527.89 millionc) $42.79

10-17 6.25%

10-18 a) $2.31525b) $5.28

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c) $24.72d) $30.00 = Maximum price you should pay for the stock.e) $30.00f) No. The value of the stock is not dependent upon the holding period. The

value calculated in Parts a through d is the value for a 3-year holding

period. It is equal to the value calculated in Part e. Any other holding

period would produce the same value of0

P ; that is,0

P = $30.00

10-19 a) Dividend yield =2.53%; Capital gains yield =5.47%b) Due to the longer period of supernormal growth, the value of the stock

will be higher for each year. Although the total return will remain the

same, rs = 10%, the distribution between dividend yield and capital gains

yield will differ: The dividend yield will start off lower and the capital

gains yield will start off higher for the 5-year supernormal growth

condition, relative to the 2-year supernormal growth state. The dividend

yield will increase and the capital gains yield will decline over the 5-year

period until dividend yield = 4% and capital gains yield = 6%

c) the capital gains yield will equal gn = 6%; dividend yield= 4%d) Some investors need cash dividends (retired people), while others would

prefer growth. Also, investors must pay taxes each year on the dividends

received during the year, while taxes on the capital gain can be delayed

until the gain is actually realized. Currently (2008), dividends to

individuals are now taxed at the lower capital gains rate of 15%

10-20 $7.52

10-21 a) $24,112,308b) $321,000,000c) $228,113,612d) $16.81

10-22 $35.00

10-23 a) D2009 =$2.01D2010 =$2.31

D2011 =$2.66

D2012 =$3.06

D2013 =$3.52

b) $39.43c) Dividend yield= 5.10%; Capital gains yield=6.90%; expected total return=

12.00%

Dividend yield= 7.00%; Capital gains yield=5.00%; expected total return=

12.00%

d) People in high-income tax brackets will be more inclined to purchasegrowth stocks to take the capital gains and thus delay the payment oftaxes until a later date. The firms stock is mature at the end of 2013.

e) Since the firms supernormal and normal growth rates are lower, thedividends and, hence, the present value of the stock price will be lower.

The total return from the stock will still be 12%, but the dividend yield will

be larger and the capital gains yield will be smaller than they were with

the original growth rates. This result occurs because we assume the same

last dividend but a much lower current stock price.

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f) As the required return increases, the price of the stock goes down, butboth the capital gains and dividend yields increase initially. Of course, the

long-term capital gains yield is still 4%, so the long-term dividend yield is

10%.