Lahore School of Economics

Financial Management I
Chapter 9
Stocks and their Valuation – 1
Assignment 12 Solution

Class Examples

Q1) D1 = $1; g = 5%; rs = 11%

Q2) Expected price = P1 = P0(1 + g) = 40(1 + 0.06) = $42.4

Expected return = r^ s = Dividend yield + Capital Gains Yield

=
= 2/40 + (42.4 – 40)/40
= 5% + 6%
= 11%

Q3) a) rs = rRF + (rM – rRF)b

= 7% + (12% – 7%)1.2
= 13%.

b) $30.285

c) P1 = P0(1 + g) = 30.285(1 + 0.06) = $32.102

d) Dividend yield = D1/P0 = 2.12/30.285 = 0.07 = 7%

Capital Gains Yield = (P1 – P0)/P0 = (32.012 – 30.285)/30.285 = 0.06 = 6%

Total Expected Return = 7% + 6% = 13%

e) If g = 0,

$15.38

Q4) P0 = $20; D0 = $1.00; g = 6%

P^ 1
= P0(1 + g) = $20(1.06) = $21.20.

=
 D1
= P0 + g

$1.00(1.06)
= $20 + 0.06
$1.06
= $20 + 0.06 = 11.30%. rs = 11.30%.

Q5)

To find the price 5 years from now,

Therefore, the firm’s expected stock price 5 years from now is $45.95.

Problems for Assignment

Q1) D0 = $1.50; g1-3 = 7%; gn = 5%

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.

Q2) D1 = $0.50; g = 7%; rs = 15%;

$6.25

Q3) D1 = $2, b = 0.9, rRF = 5.6%, RPM = 6%, P0 = $25.

Required rate of return:
rs = rRF + (rM – rRF)b = 5.6% + (6%)0.9 = 11%.
 To calculate g:

D1
= P0 + g

P^ 3
Calculate :

P^ 3 = P0(1 + g)3 = $25(1.03)3 = $27.3182  $27.32.

Q4) 0 1 2 3 4
rs = 12%
| | | | |
g = 5%
D0 = 2.00 D1 D2 D3 D4
P^ 3

a. D1 = $2(1.05) = $2.10
D2 = $2(1.05)2 = $2.2050
D3 = $2(1.05)3 = $2.31525

b. $30