Chapter 9 Exercise Questions

9-1 Mars Corporation just paid a dividend of $1.50 a share (that is, D0 = $1.50). The dividend is
expected to grow at 7% a year for the next 3 years and then at 5% a year thereafter. What is the
expected dividend per share for each of the next 5 years?
A:

D1 = D0(1 + g1) = $1.50(1.07) = $1.6050.

D2 = D0(1 + g1)(1 + g2) = $1.50(1.07)2 = $1.7174.
D3 = D0(1 + g1)(1 + g2)(1 + g3) = $1.50(1.07)3 = $1.8376.
D4 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn) = $1.50(1.07)3(1.05) = $1.9294.
D5 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn)2 = $1.50(1.07)3(1.05)2 = $2.0259
9-2 Thomas Brothers is expected to pay a $0.50 per share dividend at the end of the year (that is,
D1 = $0.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of
return on the stock, rs is 15%. What is the stock’s current value per share?
A: The stock’s current value per share is $6.25.
P^ o = D1 / (Rs - g) = (.50/ .15 - .07) = $6.25
9-3 Harrison Garment’s stock currently sells for $20.00 a share. It just paid a dividend of $1.00 a
share (that is, D0 = $1.00). The dividend is expected to grow at a constant rate of 6% a year. What
stock price is expected 1 year from now? What is the required rate of return?
A: The stock price expected 1 year from now is $21.20.
Po (1+g) = $20(1+.06) = $21.20
The required Rate of return is 11.3%.
(D1 / Po) + g = 1.00(1.06) / 20 + .06 = 11.3%
9-4 Hartman Engineering recently paid a dividend, D0, of $1.25. It expects to have nonconstant
growth of 20% a year for 2 years followed by a constant rate of 5% thereafter. The firm’s required rate
of return is 10%.
a. How far away is the horizon date?
b. What is the firm’s horizon, or continuing value?
c. What is the firm’s intrinsic value today?
A: a. The horizon date is the date when the growth rate becomes constant. This occurs at the end of
Year 2.
b.) end value / (Rs - last g) = 1.89 / (.10 - .05) = 37.80
The firms continuing value is 37.80.
c.) The firm's intrinsic value is calculated as the sum of the present value of all dividends during the
supernormal growth period plus the present value of the terminal value. The firm’s intrinsic value
today is a total of $34.09.
9-5 Smith Technologies is expected to generate $150 million in free cash flow next year, and FCF
is expected to grow at a constant rate of 5% per year indefinitely. Smith has no debt or preferred stock,
and its WACC is 10%. If Smith has 50 million shares of stock outstanding, what is the stock’s value
per share?
A:
Firm value = FCF1/(WACC - g)
= $150,000,000/(0.10 - 0.05) = $3,000,000,000
Equity value per share = Equity value/Shares outstanding
= $3,000,000,000/50,000,000 = $60.
9-6 Founders Union has perpetual preferred stock outstanding that sells for $60 a share and pays a
dividend of $5.00 at the end of each year. What is the required rate of return?
A: The required rate of return is 8.33%.
rp= Dp / Vp = 5 / 60 = 8.33%
9-7 What will be the nominal rate of return on a perpetual preferred stock with a $100 per share, a
state dividend of 8% of par, and a current market price of (a) $60, (b) $80, (c) $100, and (d) $ $140?
A:
a) rp= 8 / 60 = 13.33%
b) rp = 8 / 80 = 10%
c) rp = 8 / 100 = 8%
d) rp= 8 / 140 = 5.71%
9-8 EZ Energy issued perpetual preferred stock with a 10% annual dividend. The stock currently
yields 8%, and its par value is $100.
a. What is the stock’s value?
b. Suppose interest rates rise and pull the preferred stock’s yield up to 12%. What is the
new market value?
A:
The value of the preferred stock would be = Annual dividend ÷ annual yield
= $100 × 10% ÷ 8% = $10 ÷ 8% = $125 per share
The new market value would be = Annual dividend ÷ annual yield
= $10 ÷ 12% = $83.33 per share
9-9 Bruner Aerospace has perpetual preferred stock outstanding with a par value of $100. The
stock pays a quarterly dividend of $2.00, and its current price is $80.
a. What is the nominal annual rate of return?
b. What is its effective annual rate of return?
A:
(a) Periodic rate of return = $2/$80 = 2.5%.

Nominal rate of return = 2.5% ´ 4 = 10%.

(b) EAR = (1 + rNOM/4)^4 – 1
= (1 + 0.10/4)^4 – 1
= 0.103813 = 10.3813%.
9-10 Maxon Mining Company’s ore reserves are being depleted, so its sales are falling. Also,
because its pit is getting deeper each year, causing its costs rising. As a result, the company’s earnings
and dividends are declining, at a constant rate of 5% a year. If D0 = $5.00 and rs = 15%, what is the
value of Maxon Mining’s stock?
A:
Value of Martell Mining's stock = D0(1 + g) / (rs - g)
Value of Martell Mining's stock = $5[1 + (-0.05)] / (0.15 - (-0.05))
Value of Martell Mining's stock = $23.75