Fnce451 Midterm

Midterm Exam – October 17, 2012 SOLUTIONS Instructions: 1. Read the questions carefully. 2. Answer all questions on the following pages. 3. A financial calculator and a regular calculator are permitted. 4. A one-sided 8.5” x 11” formula sheet is permitted with formulas only. 5. The midterm has 11 pages, including 2 blank pages. 6. For Part 2, show all your work. 7. Midterm duration: 75 minutes. 8. Mark allocation: Shown on exam.

Print your name: _________________________________________ Sign your name: __________________________________________ Student Number: __________________________________________

Good Luck!!! Part 1: Multiple Choice Part 2: Short Answer and Problems Question 1 Question 2 Question 3 Question 4 Total /20 /4 /5 …show more content…

(2 points: 1 point for setting the standard deviation equal to zero to solve for π, and 1 point for final answer)

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Question 2 [5 points]: Storico Co. just paid a dividend of $3.50 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate, forever. If the required return on Storico stock is 13 percent, what will a share of stock sell for today? Answer: Here we have a stock with differential growth, where the dividend growth changes every year for the first four years. We can find the price of the stock in Year 3 since the dividend growth rate is constant after the third dividend. The price of the stock in Year 3 will be the dividend in Year 4, divided by the required return minus the constant dividend growth rate. So, the price in Year 3 will be: P3 = $3.50(1.20)(1.15)(1.10)(1.05) / (.13 – .05) = $69.73 (2 points: 1 point for set up and 1 point for answer) The price of the stock today will be the PV of the first three dividends, plus the PV of the stock price in Year 3, so: P0 = $3.50(1.20)/(1.13) + $3.50(1.20)(1.15)/1.132 + $3.50(1.20)(1.15)(1.10)/1.133 + $69.73/1.133 (2 points for set up) P0 = $59.51 (1 point)

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Question 3 [10 points]: The expected return of the S&P 500, which you