CHAPTER 02 14FINANCIAL MARKETS AND INSTITUTIONS 1

Suppose Ace, over the last few years, has had an 18 percent average return on equity (ROE) and has paid out 20 percent of its net income as dividends. Under what conditions could this information be used to help estimate the firm’s expected future growth rate, g? Estimate ks using this procedure for determining g.

21. Universal Forests current stock price is $154.00 and it is likely to pay a $5.23 dividend next year. Since analysts estimate Universal Forest will have a 13.0% growth rate what is the required return?

A constant annual rate of dividend growth of 9 per cent is expected on a particular

I. Rate of Return on Total Assets: Measures the company’s profitability relative to total assets. A percentage increment for Company G, from 12.30% to 13.68% (2011-12) keeps them above industry benchmarks (8.60% and 12.30%). Rate of Return on Total Assets represents strength for Company G.

Reinvestment Returns: I found "b" (the reinvestment rate) by using exhibit 1 to calculate the percentage of net income per share of common stock that is paid out in dividends, and subtracting it from 1 to solve for the percentage reinvested. The return on equity, "k", is found by dividing net income (exhibit 1) by book value (exhibit 2). G = b*k shows g = 8.14%.

When investing in a company, the goal is to buy shares at a low price and then sell them at a higher price. Individual stocks may go up or down independent of how “The Market” is doing overall. Stock market indices such as the Dow Jones Average, the NASDAQ, and the Standard and Poors 500 report how “The Market” is doing “on average.” To check

Expected return on market rate Rm is provided at page 175 in Myers and it is the average nominal return on stocks for the last century, the value is 11.7%

• Pe = D1/(re – g) = 700 / (0.11 – 0.05) = $11,667 • price per share = $11,667 / 1,000 = $11.67 3. Same facts as (2) above, except the 5% income growth rate (and beginning of year common equity to support it) are only expected for years 2 and 3. Then growth is expected to be zero and all income is expected to be distributed to shareholders for all future years. a. Compute D1, D2, D3, and Dt for all future years. • Keeping in mind that income is $1,100 in year 1, increases by 5% in years 2 and 3, and then remains constant for all future years; and keeping in mind that beginning of year 1 common equity is $8,000, increases by 5% at the beginning of year 2 and at the beginning of year 3, but does not increase at the beginning of year 4 and remains constant from that point forward, you should be able to compute: D1 = $700, D2 = $735, and Dt = 1,212.75 for D3 and all future years. b. Use the dividend discount (i.e., free cash flow to equity investors) valuation model to estimate the company’s current stock price. Pe = 700/(1+ 0.11) + 735/(1+ 0.11)2 + [1,212.75/0.11]/(1+ 0.11)2 = $10,175.31 and the price per share of common stock = $10,175.31 / 1,000 = $10.18. 4. Same facts as (3) above, except the growth rates are 5% for years 2 and 3 and then 3% perpetually for all future years. a. Compute D1, D2, D3 and the growth in D for all future years. • Keeping in mind that income is $1,100 in year 1, increases by 5% in years 2

* We assume the cost of capital to be a stated annual rate to facilitate calculations;

10. I used November 4, 2014, data to calculate the daily return on holding Under Armour shares for the past year:

3. An analysis of stock market conditions including recent returns on stock market indexes and average valuation ratios such as P/E ratios of stock market indexes.

Corporate Finance ADM 3350 M & P (Winter 2015) Assignment 1 Due Date: February 23, 2015 Question 1 (5 Marks) Varta Inc. has just issued a dividend of $1.50 per share on its common stock. The company paid dividends of $1.10, $1.15, $1.25, and $1.37 per share in the last four years. The stock currently sells for $48. a. What is your best estimate of the company's cost of equity capital using the arithmetic average growth rate in dividends? b. What if you use the geometric average growth rate? Solution: (3 + 2 = 5 Marks)

The twelfth term is rate of return. This is articulated as a fraction of the sum amount invested.

First, identify the returns for the S&P 500 for the last year, last 3 years and last 5 years: According to the Wall Street Journal, the one-year return for the S&P 500 as of February stood at 10.91%, the three-year return for the same period is 37.14% the five-year return for the S&P 500 is currently at 13.83% (Russolillo, 2013).

The standard method of calculating a stock price using the perpetual dividend growth model is done by assessing a company’s dividend one year into the future adding the future expected growth rate. The formula is written as: P0 = D1/(Ke − g), where Ke is the investor required return, D1 is next year’s dividend and g is the