Question: Over the past 10 years, the dividends of Party Time Inc. have grown at an annual rate of 15 percent. The current (D0) dividend is $2.5 per share. This dividend is expected to grow to $3.0 next year, then grow at an annual rate of 10 percent for the following two years and 6 percent per year thereafter.

Contemporary Financial Management Homework #4 Chap 7

Please show your calculations either in the uploaded Excel file or in a word document.

Stock valuation

7-1 Over the past 10 years, the dividends of Party Time Inc. have grown at an annual rate of 15 percent. The current (D0) dividend is $2.5 per share. This dividend is expected to grow to $3.0 next year, then grow at an annual rate of 10 percent for the following two years and 6 percent per year thereafter. You require a 15 percent rate of return on this stock.

a. What would you be willing to pay for a share of Party Time stock today?

b. What price would you anticipate the stock selling for at the beginning of year 3?

c. If you anticipated selling the stock at the end of two years, how much would you pay for it today?

7-2 Excel Corporation has recently witnessed a period of depressed earnings performance. As a result, cash dividend payments have been suspended.

i.          Investors do not anticipate a resumption of dividends until two years from today, when a yearly dividend of $0.50 will be paid.

ii.         That yearly dividend is expected to be increased to $1.00 in the following year and $1.50 in the year after that.

iii.        Beyond the time when the $1.50 dividend is paid, investors expect Excel’s dividends to grow at an annual rate of 5 percent into perpetuity.

iv.        All dividends are assumed to be paid at the end of each year.

If you require an 18 percent rate of return on Excel’s stock,

what is the value of one share of this stock to you today?

7.3 The VSE Corporation currently pays no dividend because of depressed earnings. A recent change in management promises a brighter future. Investors expect VSE to pay a dividend of $1 next year (the end of year 1).

This dividend is expected to increase to $2.25 the following year and to grow at a rate of 10 percent per annum for the following two years (years 3 and 4).

Chuck Brown, a new investor, expects the price of the stock to increase 75 percent in value between now (time zero) and the end of year 3.

If Brown plans to hold the stock for three years and requires a rate of return of 25 percent on his investment, what value would he place on the stock today?