Computer Corp. reinvests 50% of its earnings in the firm. The stock sells for $55, and the next dividend will be $2.20 per share. The discount rate is 15%. What is the rate of return on the company’s reinvested funds?

Computer Corp. reinvests 50% of its earnings in the firm. The stock sells for $55, and the next dividend will be $2.20 per share. The discount rate is 15%. What is the rate of return on the company’s reinvested funds? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Rate of return

%

Explanation:

$55	=	$2.20		g	=	0.15	−	$2.20	=	0.11	=	11.00%
		0.15 − g						$55

   

g = 0.11 = return on equity × plowback ratio = return on equity × 0.50

return on equity = 0.11/0.50 = 0.2200 = 22.00%

Grandiose Growth has a dividend growth rate of 10%. The discount rate is 8%. The end-of-year dividend will be $5 per share.

Grandiose Growth has a dividend growth rate of 10%. The discount rate is 8%. The end-of-year dividend will be $5 per share.

a.	What is the present value of the dividend to be paid in year 1? Year 2? Year 3? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Present Value
Year 1	$
Year 2
Year 3

Explanation:

a.

DIV1 = $5.00	PV = $5/1.08 = $4.63
DIV2 = $5(1.10) = $5.50	PV = $5.50/1.082 = $4.72
DIV3 = $5(1.10)2 = $6.05	PV = $6.05/1.083 = $4.80

Assume that market and book values are equal for current assets, current liabilities, and debt and other long-term liabilities.

Assume that market and book values are equal for current assets, current liabilities, and debt and other long-term liabilities.

SIMPLIFIED BALANCE SHEET OF GOOD FORTUNES, INC. FOR MAY 31, 2010 (Millions of dollars)
Current assets	$	7,290	Current liabilities	$	4,651
Plant, equipment and other long-term assets		17,630	Debt and other long-term liabilities		6,452
			Shareholders’ equity		13,817
Total assets	$	24,920	Total liabilities and equity	$	24,920

Note: Shares of stock outstanding: 320 million. Book value of equity (per share): 13,817/320 = $43.18. The stock price is $77.50.

a.	Construct a market-value balance sheet from the above data. (Be sure to list the assets and liabilities in order of their liquidity. Enter your answers in millions rounded to 2 decimal places.)

SIMPLIFIED BALANCE SHEET OF GOOD FORTUNES, INC. FOR MAY 31, 2010 (Millions of dollars)
Current assets	$	Current liabilities	$
Plant, equipment and other long-term assets		Debt and other long-term liabilities
Growth opportunities		Shareholders' equity
Total assets	$	Total liabilities and equity	$

b.	How much extra value shows up on the asset side of the balance sheet? (Enter your answer in millions rounded to 2 decimal places.)

Extra value on the asset side

$ million

Explanation:

The market value of shareholders' equity is found as the price per share ($77.50) multiplied by the number of shares outstanding (320 million), or $24,800,000,000. An additional $10,983,000,000 shows up on the asset side of the balance sheet ($24,800,000,000 − 13,817,000,000).

No-Growth Industries pays out all of its earnings as dividends. It will pay its next $4 per share dividend in a year. The discount rate is 15%.

No-Growth Industries pays out all of its earnings as dividends. It will pay its next $4 per share dividend in a year. The discount rate is 15%.

a.	What is the price-earnings ratio of the company? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

P/E ratio

b.	What would the P/E ratio be if the discount rate were 10%? (Round your answer to 2 decimal places.)

P/E ratio

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations.

a.

Earnings = DIV1 = $4

Growth rate = g = 0

P0 =	$4	= $26.67
	0.15 − 0

P/E = $26.67/$4 = 6.67

b.

If r = 0.10 P0 =	$4	= $40 P/E increases to $40/$4 = 10.00.
	0.10

You expect a share of stock to pay dividends of $1.90, $2.15, and $2.40 in each of the next 3 years. You

You expect a share of stock to pay dividends of $1.90, $2.15, and $2.40 in each of the next 3 years. You believe the stock will sell for $31 at the end of the third year.

a.	What is the stock price if the discount rate for the stock is 10%? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Stock price

$

b.	What is the dividend yield? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Dividend yield

%

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations.

a.

P0	=	$1.90	+	$2.15	+	$2.40 + $31	=	$28.60
		1.10		(1.10)2		(1.10)3

b.

DIV1/P0 = $1.90/$28.60 = 0.0664 = 6.64%

Horse and Buggy Inc. is in a declining industry. Sales, earnings, and dividends are all shrinking at a rate of 10% per year.

Horse and Buggy Inc. is in a declining industry. Sales, earnings, and dividends are all shrinking at a rate of 10% per year.

a.	If r = 15% and DIV1 = $2, what is the value of a share? (Do not round intermediate calculations.)

Value of a share

$

b.	What price do you forecast for the stock next year? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Stock price

$

c.	What is the expected rate of return on the stock? (Do not round intermediate calculations.)

Expected rate of return

%

Explanation:

a.

P0 = DIV1/(r − g) = $2/[0.15 − (−0.10)] = $2/0.25 = $8

b.

P1 = DIV2/(r − g) = $2(1 − 0.10)/0.25 = $7.20

c.

Expected rate of return	=	DIV1 + capital gain	=	$2 + ($7.20 − $8)	=	0.15 = 15%
		P0		$8

Arts and Crafts, Inc., will pay a dividend of $6 per share in 1 year. It sells at $50 a share and firms in

Arts and Crafts, Inc., will pay a dividend of $6 per share in 1 year. It sells at $50 a share and firms in the same industry provide an expected rate of return of 15%. What must be the expected growth rate of the company’s dividends? (Do not round intermediate calculations.)

Expected growth rate

3  %

Explanation:

$50	=	$6		g	=	0.15	−	$6	=	0.03	=	3%
		0.15 − g						$50

Integrated Potato Chips paid a $2.70 per share dividend yesterday. You expect the dividend to grow steadily at a rate of 6% per year.

Integrated Potato Chips paid a $2.70 per share dividend yesterday. You expect the dividend to grow steadily at a rate of 6% per year.

a.	What is the expected dividend in each of the next 3 years? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Expected Dividend
Year 1	$
Year 2
Year 3

b.	If the discount rate for the stock is 10%, at what price will the stock sell? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Current price

$

c.	What is the expected stock price 3 years from now? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Future price

$

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? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Year 1	Year 2	Year 3
DIV	$	$	$
Selling price
Total cash flow
PV of cash flow