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Common Stocks - Worksheet

The document provides examples of calculating stock prices, growth rates, and returns using common financial metrics like dividend payout ratio, return on equity, plowback ratio, market capitalization rate, beta, and risk-free rate of return. It works through 9 examples of valuation questions, with the last involving calculating the intrinsic value and one-year expected return on a stock given its beta, earnings, dividend payout ratio, and expected return on equity.

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76 views

Common Stocks - Worksheet

The document provides examples of calculating stock prices, growth rates, and returns using common financial metrics like dividend payout ratio, return on equity, plowback ratio, market capitalization rate, beta, and risk-free rate of return. It works through 9 examples of valuation questions, with the last involving calculating the intrinsic value and one-year expected return on a stock given its beta, earnings, dividend payout ratio, and expected return on equity.

Uploaded by

vwfn8f7xmt
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Common Stocks WS

1) Company X is expected to pay an end-of-year dividend of $5 a share. After the


dividend, its stock is expected to sell at $110. If the cost of equity is 8%, what is
the current stock price?
D1 = $ 5
P1 = $ 110
r = 8% = 0.08
P0 = ?

P0 = D1 + P1 / 1 + r
= 5 + 110 / 1 + 0.08
= $ 106.48

2) Company Y does not plow back any earnings and is expected to produce a level
dividend stream of $5 a share. If the current stock price is $40, what is the cost
of equity?
g=0
D1 = $ 5
P0 = $ 40
r=?

r = (D1 / P0) + g
= (5 / 40) + 0
= 0.125 = 12.5%
3) Elk City Utility recently paid a dividend of $3.77 per share. Dividends are
expected to grow at a rate of 3.90%. Elk City stock currently sells for $38.20
per share. If you were on the utility regulatory commission, what rate of return
would you allow Elk City to earn?
D0 = $ 3.77
g = 3.90%
P0 = $ 38.20
r=?

D1 = D0 x (1+g)
= 3.77 x (1 + 0.039)
= 3.92

r = (D1 / P0) + g
= (3.92 / 38.20) + 0.0390
= 0.1416 = 14.16 %

4) The common stock of Royal Ranch House is selling for $20.23. The firm pays
dividends that are expected to grow at a rate of 4.40% indefinitely. Your
investment horizon is 9 years. What do you estimate the price of Royal Ranch
House stock will be at that time?
P0 = $ 20.23
g = 4.40 %
N=9
P1 = ?

Pn = P0 x (1 + g)!
P9 = 20.23 x (1 + 0.0440)"
= $ 29.8058
5) The market capitalization rate for Admiral Motors Company is 12%. Its
expected ROE is 15% and its expected EPS is $7. The firm's plowback ratio is
40%.
r = 12 %
ROE = 15 %
EPS = $ 7
b = 40 %
a) Calculate the growth rate.
g=?
g = ROE x b
= 0.15 x 0.40
= 0.06 = 6 %

b) What will be its P/E ratio?


P/E = ?
P/E = (1 – b) / (r – g)
= (1 – 0.40) / (0.12 – 0.06)
= 10
6) Even Better Products has come out with an even better product. As a result, the
firm projects an ROE of 30%, and it will maintain a plowback ratio of 0.30. Its
earnings this year will be $2 per share. Investors expect a 16% rate of return on
the stock.
ROE = 30 %
b = 0.30
D1 = $ 2
r = 16 %

a) At what price and P/E ratio would you expect the firm to sell?
P = ? & P/E = ?

g = ROE x b
= 0.30 x 0.30
= 0.09 = 9 %

P/E = (1 – b) / (r – g)
= (1 – 0.30) / (0.16 – 0.09)
= 10

P = D1 / (r – g)
= 2 / (0.16 – 0.09)
= $ 28.57

b) What is the present value of growth opportunities?


7) Here are forecasts for next year for two stocks:

Stock A Stock B

Return on equity 14% 13%

Earnings per share $ 4.00 $ 3.50

Dividends per share $ 2.00 $ 2.00

a. What are the dividend payout ratios for each firm?


Dividend Payout Ratio (DPR) = DPS/EPS
Stock A = 2 / 4
= 0.5
Stock B = 2 / 3.50
= 0.57

b. What are the expected sustainable dividend growth rates for each stock?
Assume dividend has a steady growth for both stocks.
Plowback Ratio (b) = 1 – DPR
g = ROE x b

Stock A:
b = 1 – 0.5 = 0.5
g = 0.14 x 0.5 = 0.07 = 7 %

Stock B:
b = 1 – 0.57 = 0.43
g = 0.13 x 0.43 = 0.0559 = 5.59 %

c. If investors require a return of 14% on each stock, what are their values?
r = 14 %, P = ?
P = DPS / (r – g)

Stock A = 2 / (0.14 – 0.07) = $ 28.57


Stock B = 2 / (0.14 – 0.0559) = $ 23.78
8) MF Corporation has an ROE of 10% and a plowback ratio of 50%. If the
coming year's earnings are expected to be $2 per share,
ROE = 10 %
b = 50 %
EPS = $ 2
a) at what price will the stock sell? The market capitalization rate is 15.
r = 15 %, P = ?

g = ROE x b
= 0.10 x 0.50
= 0.05 = 5 %

D = EPS x b
= 2 x (1 - 0.50)
=1

P = D / (r – g)
= 1 / (0.15 – 0.05)
= $ 10

b) What price do you expect MF shares to sell for in three years?


N=3
Pn = ROE x (1 + g)!
P3 = 0.10 x (1 + 0.05)#
= $ 11.58
9) The risk-free rate of return is 10.0%, the expected rate of return on the market
portfolio is 20%, and the stock of Xyrong Corporation has a beta coefficient of 2.6.
Xyrong pays out 60% of its earnings in dividends, and the latest earnings
announced were $25 per share. Dividends were just paid and are expected to be
paid annually. You expect that Xyrong will earn an ROE of 22% per year on all
reinvested earnings forever.

a) What is the intrinsic value of a share of Xyrong stock?


b) If the market price of a share is currently $60 and you expect the market price to
be equal to the intrinsic value one year from now, calculate the price of the share
after one year from now.
c) What is your expected one-year holding-period return on Xyrong stock?

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