Stock Valuation

STOCK VALUATION
1. The Jones Company has decided to undertake a large project.

Consequently, there is a need for additional funds. The financial
manager plans to issue preferred stock with a perpetual annual
dividend of $5 per share and a par value of $30. If the required
return on this stock is currently 20 percent, what should be the
stock’s market value?
a. $150
b. $100
c. $ 50
d. $ 25
e. $ 10
2 Womack Toy Company’s stock is currently trading at $25 per share.

The stock’s dividend is projected to increase at a constant rate
of 7 percent per year. The required rate of return on the stock,
ks, is 10 percent. What is the expected price of the stock 4
years from today?
a. $36.60
b. $34.15
c. $28.39
d. $32.77
e. $30.63
3 Allegheny Publishing’s stock is expected to pay a year-end dividend,

D1, of $4.00. The dividend is expected to grow at a constant rate
of 8 percent per year, and the stock’s required rate of return is
12 percent. Given this information, what is the expected price of
the stock, eight years from now?
a. $200.00
b. $185.09
c. $171.38
d. $247.60
e. $136.86
1
4 Thames Inc.’s most recent dividend was $2.40 per share (i.e., D 0 =
$2.40). The dividend is expected to grow at a rate of 6 percent
per year. The risk-free rate is 5 percent and the return on the
market is 9 percent. If the company’s beta is 1.3, what is the
price of the stock today?
a. $72.14
b. $57.14
c. $40.00
d. $68.06
e. $60.57
5 Albright Motors is expected to pay a year-end dividend of $3.00 a

share (D1 = $3.00). The stock currently sells for $30 a share.
The required (and expected) rate of return on the stock is 16
percent. If the dividend is expected to grow at a constant rate,
g, what is g?
a. 13.00%
b. 10.05%
c. 6.00%
d. 5.33%
e. 7.00%
6 A stock with a required rate of return of 10 percent sells for $30

per share. The stock’s dividend is expected to grow at a constant
rate of 7 percent per year. What is the expected year-end
dividend, D1, on the stock?
a. $0.87
b. $0.95
c. $1.02
d. $0.90
e. $1.05
7 The last dividend paid by Klein Company was $1.00. Klein’s growth
rate is expected to be a constant 5 percent for 2 years, after
which dividends are expected to grow at a rate of 10 percent
forever. Klein’s required rate of return on equity (ks) is 12
percent. What is the current price of Klein’s common stock?
a. $21.00
b. $33.33
c. $42.25
d. $50.16
e. $58.75
2
8 Waters Corporation has a stock price of $20 a share. The stock’s
year-end dividend is expected to be $2 a share (D1 = $2.00). The
stock’s required rate of return is 15 percent and the stock’s
dividend is expected to grow at the same constant rate forever.
What is the expected price of the stock seven years from now?
a. $28
b. $53
c. $27
d. $23
e. $39
9 A stock is not expected to pay a dividend over the next four years.
Five years from now, the company anticipates that it will
establish a dividend of $1.00 per share (i.e., D5 = $1.00). Once
the dividend is established, the market expects that the dividend
will grow at a constant rate of 5 percent per year forever. The
risk-free rate is 5 percent, the company’s beta is 1.2, and the
market risk premium is 5 percent. The required rate of return on
the company’s stock is expected to remain constant. What is the
current stock price?
a. $ 7.36
b. $ 8.62
c. $ 9.89
d. $10.98
e. $11.53
10 R. E. Lee recently took his company public through an initial

public offering. He is expanding the business quickly to take
advantage of an otherwise unexploited market. Growth for his
company is expected to be 40 percent for the first three years and
then he expects it to slow down to a constant 15 percent. The
most recent dividend (D0) was $0.75. Based on the most recent
returns, the beta for his company is approximately 1.5. The risk-
free rate is 8 percent and the market risk premium is 6 percent.
What is the current price of Lee’s stock?
a. $77.14
b. $75.17
c. $67.51
d. $73.88
e. $93.20
3
ANSWERS:
1. Vp = Dp/kp = $5/0.20 = $25.
2. The stock price will grow at 7 percent for 4 years, $25 

(1.07)4 = $32.77.
3. The stock price today is calculated as:

$4/(0.12 - 0.08) = $100. If the growth rate is 8 percent, the
price in 8 years will be: $100  (1.08)8 = $185.09.
4. The required rate of return on the stock is 5% + (9% - 5%)1.3 =

10.2%. D1 = $2.40  1.06 = $2.544. The price of the stock today is
$2.544/ (0.102 - 0.06) = $60.57.
5. P0 = D1/(ks - g)
$30 = $3/(0.16 – g)
$4.8 - $30g = $3
$1.8 = $30g
g = 6%.
6. We know that P0 = D1/(ks - g) and we have all the information

except D1, so we input the data into this equation.
$30 = D1/(0.10 - 0.07)
$30 = 33.33D1
D1 = $0.90.
7.
0 k=1
2%
1 2 3
| | | |
g=5
% g=1
0%
1
.00 1.
05 g=5% 1
.10
25 1
.21
28

P2 =
1.2128
=60
.63
75
0.12
-0.10
CFt0 1
.05 6
1.7
400
Numerical solution:
$1.05 $61.74
P0 = + = $50.16.
(1.12) (1.12)2
Financial calculator solution:

Enter in CFLO register CF0 = 0, CF1 = 1.05, and CF2 = 61.74.
Then enter I = 12, and press NPV to get NPV = P0 =
$50.16
4
8. Step 1: Find g:
P0 = D1/(ks - g)
$20 = $2/(0.15 - g)
g = 5%.
Step 2: Find P at t = 7:
P̂ 7 = P0(1 + g)7
P̂ 7 = $20(1.05)7
P̂ 7 = $28.14  $28.
9. The required return on the stock is given by:

ks = kRF + RPM(b)
ks = 5% + (5%)1.2 = 11%.
The stock price is given by:

D5
P4 =
ks  g
$1.00
=
0.11 - 0.05
= $16.667.
Thus, the current price is given by discounting the future price

in Year 4 to the present at the required rate of return:
$16.667
P̂0   $10.98.
(1.11)4
10. ks = kRF + RPM(b)

= 8% + 6%(1.5)
= 17%.
D1 = $0.75(1.4) = $1.05.
D2 = $0.75(1.4)2 = $1.47.
D3 = $0.75(1.4)3 = $2.058.
D4 = $0.75(1.4)3(1.15) = $2.3667.
P3 = D4/ks - g
= $2.3667/(0.17 - 0.15)
= $118.335.
$1.05 $1.47 $2.058 + $118.335

P0 = + 2
+
1.17 (1.17 ) (1.17 )3
= $77.14.

Stock Valuation

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STOCK VALUATION

1. The Jones Company has decided to undertake a large project.

2 Womack Toy Company’s stock is currently trading at $25 per share.

3 Allegheny Publishing’s stock is expected to pay a year-end dividend,

5 Albright Motors is expected to pay a year-end dividend of $3.00 a

6 A stock with a required rate of return of 10 percent sells for $30

10 R. E. Lee recently took his company public through an initial

1. Vp = Dp/kp = $5/0.20 = $25.

2. The stock price will grow at 7 percent for 4 years, $25 

3. The stock price today is calculated as:

4. The required rate of return on the stock is 5% + (9% - 5%)1.3 =

6. We know that P0 = D1/(ks - g) and we have all the information

Financial calculator solution:

9. The required return on the stock is given by:

The stock price is given by:

Thus, the current price is given by discounting the future price

10. ks = kRF + RPM(b)

$1.05 $1.47 $2.058 + $118.335

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