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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

VALUATION OF A CONSTANT GROWTH STOCK Investors require an 8% rate of return on Mather Company’s stock (i.e., rs = 8%).

  1. a. What is its value if the previous dividend was D0 = $125 and investors expect dividends to grow at a constant annual rate of (1) −2%, (2) 0%, (3) 3%, or (4) 5%?
  2. b. Using data from part a, what would the Gordon (constant growth) model value be if the required rate of return was 8% and the expected growth rate was (1) 8% or (2) 12%? 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?

  1. a. (1)
Summary Introduction

To compute: The value of stock for Company M with constant growth in dividends.

Introduction:

Value of Stock:

Value of stock is an amount computed to evaluate the stock of a company for investment purpose. It determines the dividends 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 information:

Dividend is $1.25.

Required rate of return is 8% or 0.08.

Growth rate is –2% or 0.02.

Formula to compute stock value,

P0=D0×(1+g)rsg

Where,

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

(2)

Summary Introduction

To compute: The value of stock for Company M with constant growth in dividends.

(3)

Summary Introduction

To compute: The value of stock for Company M with constant growth in dividends.

(4)

Summary Introduction

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

  1. b. (1)
Summary Introduction

To compute: The value of stock for Company M with constant growth in dividends.

(2)

Summary Introduction

To compute: The value of stock for Company M 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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