Chapter 7 Questions

Chapter 7

1. The common stock of Four Feathers Inc. sells for $40.00 a share. The stock is expected to pay
$1.35 per share next year. Four Feathers have established a pattern of increasing their dividends
by 5.2 percent annually and expects to continue doing so. What is the required rate of return on
this stock?

D1 1.35
R= +g= + .052 = .03375 + .052 = .08575 or 8.575%
P0 40.00

2. The price I would be willing to buy Harley Davidson stock is $46.27 per share, but other
people only want to sell at $46.90. Which is the “bid” price and which is the “ask” price?

(1) Bid price=the price at which buyer wants to buy=$46.27

(2) Ask price=the price at which seller wants to sell=$46.90

3. The last 3 dividends were $2.20, $2.30 and $2.44. What is the expected growth rate of the
dividends?

(1) Use your calculator: N=2, PV=−$2.2, PMT=0 & FV=$2.44 → press CPT & I/Y → I/Y=5.313
2.3 2.44 4.55%+6.09%
(2) Alternative method: g 2 = 2.2 − 1 = .0455, g 3 = 2.3
−1 = .0609 ⇒ 2
= 5.32%

4. XYZ, Inc. just paid a dividend of $2.35 per share on its stock. The dividends are expected to
grow at a constant rate of 4.5 percent per year, indefinitely. If investors require an 11 percent
return on this stock, what are you willing to pay to purchase one share of stock today?

D1 D0 (1 + g) $2.35(1 + 4.5%)
P0 = = = = $37.78
R−g R−g 11% − 4.5%
5. The next dividend payment by Mosby, Inc. will be $2.45 per share. The dividends are
anticipated to maintain a 5.5 percent growth rate, forever. If the stock currently sells for $48.50
per share, what is the implied required rate of return? What is the dividend yield?

The implied required rate of return

D1 D1 $2.45
P0 = ⇒R= +g = + 5.5% = 10.55%
R−g P0 $48.50

The dividend yield: D1/P0=$2.45/$48.50=5.05%

6. Taylor Corporation is growing quickly. Dividends are expected to grow at a 30 percent rate for
the next three years, with the growth rate falling off to a constant 6 percent thereafter. If the
required return is 13 percent and the company just paid a $2.75 dividend, what is the current
share price?

7. Plastics, Inc. will pay an annual dividend of $1.85 next year. The company just announced that
future dividends will be increasing by 2.25 percent annually. How much are you willing to pay
for one share of this stock if you require a 16 percent return?

D1 $1.85
P0 = = = $13.45
R − g 16% − 2.25%
8. Atlas Home Supply has paid a constant annual dividend of $2.40 a share for the past 15 years.
Yesterday, the firm announced the dividend will increase next year by 10 percent and will stay at
that level (no growth) through year three, after which time the dividends will increase by 2
percent annually. The required return on this stock is 12 percent. What is the current value per
share?

9. New Gadgets is growing at a very fast pace. As a result, the company expects to pay annual
dividends of $0.55, 0.80, and $1.10 per share over the next three years, respectively. After that,
the dividend is projected to increase by 5 percent annually. The last annual dividend the firm
paid was $0.40 a share. What is the current value of this stock if the required return is 16
percent?