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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

VALUATION OF A CONSTANT GROWTH STOCK Investors require a 15% rate of return on Levine Company’s stock that is, rs = 15%).

  1. a. What is its value if the previous dividend was D0 = $2 and investors expect dividends to grow at a constant annual rate of (1) −5%, (2) 0%, (3) 5%, or (4) 10%?
  2. b. Using data from Part a, what would the Gordon (constant growth) model value be if the required rate of return was 15% and the expected growth rate was (1) 15% or (2) 20%? Are these reasonable results? Explain.
  3. c. Is it reasonable to think that a constant growth stock could have g > rs? Why or why not?

a. (1)

Summary Introduction

To compute: The value of stock for company L with constant growth in dividends.

Value of Stock:

Value of stock is an amount computed to evaluate the stock of a company for investment purposes. It determines the dividend payout at the present value at required rate of return less growth rate or plus growth rate for stock with declining growth in dividends.

Explanation

Given,

Dividend is $2.

Required rate of return is 15%.

Growth rate is 5% .

Formula to compute stock value,

P0=D0×(1+g)rsg

Where,

  • D0 is dividend.
  • P0 is current value of stock.
  • rs is required rate of return

(2)

Summary Introduction

To compute: The value of stock for company L with constant growth in dividends.

(3)

Summary Introduction

To compute: The value of stock for company L with constant growth in dividends.

(4)

Summary Introduction

To compute: The value of stock for company L with constant growth in dividends.

b. (1)

Summary Introduction

To compute: The value of stock for company L with constant growth in dividends.

(2)

Summary Introduction

To compute: The value of stock for company L with constant growth in dividends.

c.

Summary Introduction

To explain: If a constant growth stock can have growth rate more than required rate of return.

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