PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 16, Problem 29PS
Dividend policy and the
The current price of the shares of Charles River Mining Corporation is $50. Next year’s earnings and dividends per share are $4 and $2, respectively. Investors expect perpetual growth at 8% per year. The expected
We can use the perpetual-growth model to calculate stock price:
Suppose that Charles River Mining announces that it will switch to a 100% payout policy, issuing shares as necessary to finance growth. Use the perpetual-growth model to show that current stock price is unchanged.
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Which statement is NOT correct?
Multiple Choice
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O
As the payout ratio goes up, the stock price also goes up.
DDM can be used to calculate the terminal value.
According to DDM, the discount rate should be greater than the growth rate of dividends.
According to DDM formula, there is a one period lag between the times of stock price and the
dividend payment.
If the payout ratio is fixed, the growth rates of earnings and dividends are same.
Company DELTA has just paid a dividend of $1.15. The required rate if return on the stock is 13.4% and investors expect the dividend to grow at a constant rate of 8% in the future.
a)Calculate the current stock value using the Gordon Constant growth model.
b)Evaluate Gordon growth model and explain its limitations and why in certain situations the growth model used in part (a) will create incorrect results?
suggests that an increase in the dividend growth rate will increase the value of a stock. However, an increase in the growth may require an increase in retained earnings and a reduction in the current dividend. Thus, management may be faced with a dilemma: current dividends versus future growth. As of now, investors’ required return is 9 percent. The current dividend is $1.3 a share and is expected to grow annually by 4 percent, so the current market price of the stock is $27.04. Management may make an investment that will increase the firm’s growth rate to 5 percent, but the investment will require an increase in retained earnings, so the firm’s dividend must be cut to $0.9 a share. Should management make the investment and reduce the dividend? Round your answer to the nearest cent.
The value of the stock to $ , so the management make the investment and decrease the dividend.
Chapter 16 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 16 - Dividend payments In 2017, Entergy paid a regular...Ch. 16 - Dividend payments Seashore Salt Co. has surplus...Ch. 16 - Repurchases Look again at Problem 2. Assume...Ch. 16 - Repurchases An article on stock repurchase in the...Ch. 16 - Company dividend policy Here are several facts...Ch. 16 - Prob. 7PSCh. 16 - Information content of dividends What is meant by...Ch. 16 - Information content of dividends Does the good...Ch. 16 - Information content of dividends Generous dividend...Ch. 16 - Prob. 11PS
Ch. 16 - Payout policy in perfect capital markets Go back...Ch. 16 - Payout policy in perfect capital markets Go back...Ch. 16 - Payout policy in perfect capital markets Respond...Ch. 16 - Prob. 15PSCh. 16 - Repurchases and the DCF model Hors dAge...Ch. 16 - Repurchases and the DCF model Surf Turf Hotels is...Ch. 16 - Repurchases and the DCF model House of Haddock has...Ch. 16 - Repurchases and the DCF model Little Oil has 1...Ch. 16 - Repurchases and EPS Many companies use stock...Ch. 16 - Dividends and value We stated in Section 16-3 that...Ch. 16 - Payout and valuation Look back one last time at...Ch. 16 - Dividend clienteles Mr. Milquetoast admires Warren...Ch. 16 - Prob. 24PSCh. 16 - Payout and taxes Which of the following U.S....Ch. 16 - Prob. 26PSCh. 16 - Prob. 27PSCh. 16 - Prob. 28PSCh. 16 - Dividend policy and the dividend discount model...Ch. 16 - Prob. 30PS
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- The dividend-growth model, suggests that an increase in the dividend growth rate will increase the value of a stock. However, an increase in the growth may require an increase in retained earnings and a reduction in the current dividend. Thus, management may be faced with a dilemma: current dividends versus future growth. As of now, investors’ required return is 12 percent. The current dividend is $0.9 a share and is expected to grow annually by 8 percent, so the current market price of the stock is $24.3. Management may make an investment that will increase the firm’s growth rate to 9 percent, but the investment will require an increase in retained earnings, so the firm’s dividend must be cut to $0.4 a share. Should management make the investment and reduce the dividend? Round your answer to the nearest cent. The value of the stock to $ , so the management make the investment and decrease the dividend.arrow_forwardThe stock of Business Adventures sells for $40 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows: Boom Normal economy Recession Expected return Standard deviation Dividend $ 2.80 1.80 0.90 Required: a. Calculate the expected holding-period return and standard deviation of the holding-period return. All three scenarios are equally likely. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return Standard deviation Stock Price $ 48 43 34 b. Calculate the expected return and standard deviation of a portfolio invested half in Business Adventures and half in Treasury bills. The return on bills is 5%. (Do not round intermediate calculations. Round your answers to 2 decimal places.) % %arrow_forwardAssuming yourself to be Anna, narrate what you would have read in the file. Your narrative should include answers to the following: Note: 1 Retention ratio = 1 – Dividend payout ratio a) If after changing the dividend policy to a 70% payout, Chatterbox grows at a 3% rate, what would be the implied ACTUAL return on equity and stock price? Does the stock price rise or fall? Why?arrow_forward
- 1. The rate at which a stock's price is expected to appreciate (or depreciate) is called the yield. A. current B. total C. dividend D. capital gains 2. The underlying assumption of the dividend growth model is that a stock is worth: A. the present value of the future income that the stock generates. B. the same amount to every investor regardless of his desired rate of return. C. an amount computed as the next annual dividend divided by the market rate of retum. D. an amount computed as the next annual dividend divided by the required rate of return. 3. The total rate of return earned on a stock is composed of which two of the following? 1. current yield II. yield to maturity III. dividend yield IV. capital gains yield A. I and II only B. I and IV only C. II and III only D. III and IV only 4. Which one of the following correctly defines the constant dividend growth model? A. R = (D₁ Po) + g B. Po = (D₁R) + g C. R=(Po Do) + g D. Po = Do ] (R-g) 5. How much are you willing to pay for one…arrow_forwardThe stock of Business Adventures sells for $50 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows: Dividend Stock Price Boom $ 3.00 $ 58 Normal economy 1.40 52 Recession 0.70 43 Required: a Calculate the expected holding - period return and standard deviation of the holding - period return. All three scenarios are equally likely. (Do not round intermediate calculations. Round your answers to 2 decimal places.) b. Calculate the expected return and standard deviation of a portfolio invested half in Business Adventures and half in Treasury bills. The return on bills is 3%. (Do not round intermediate calculations. Round your answers to 2 decimal places.)arrow_forwardThe stock of Business Adventures sells for $40 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows: Boom Normal economy Recession Expected return Standard deviation Dividend $2.00 1.00 0.50 a. Calculate the expected holding-period return and standard deviation of the holding-period return. All three scenarios are equally likely. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Stock Price $50 43 34 Expected return Standard deviation % % b. Calculate the expected return and standard deviation of a portfolio invested half in Business Adventures and half in Treasury bills. The return on bills is 4%. (Do not round intermediate calculations. Round your answers to 2 decimal places.) % %arrow_forward
- The stock of Business Adventures sells for $35 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows: Boom Normal economy Recession Dividend $ 2.50 2.00 0.85 Stock Price $ 43 40 31 Required: a. Calculate the expected holding-period return and standard deviation of the holding-period return. All three scenarios are equally likely. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return Standard deviation % % b. Calculate the expected return and standard deviation of a portfolio invested half in Business Adventures and half in Treasury bills. The return on bills is 3%. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return Standard deviation % %arrow_forwardWhich one of the following is an underlying assumption of the dividend growth model? - A stock's value changes in direct relation to the required return. - A stock has the same value to every investor. - The dividend growth rate is inversely related to a stock's market price. - A stock's value is equal to the discounted present value of the future cash flows that it generates. - Stocks that pay the same annual dividend have equal market values.arrow_forwardDAS Co. is preparing its financial forecast for next year and its AFN is negative. This means that Select one: O a. the predicted change in total assets must be negative. O b. sales growth must be negative. O c. the dividend payout ratio must be greater than the predicted growth rate in sales. O d. the predicted change in spontaneous liabilities must be greater than the predicted change in total assets.arrow_forward
- A company is considering the following two dividend policies for the next five years. Year Policy #1 Policy #2 4.00 6.90 2 4.00 2.40 4.00 5.00 4 4.00 1.70 4.00 4.00 Required: A. What is the total of the dividends per share that the stockholders will receive over the full five year period? B. If investors see no difference in the risk between the two policies, and therefore apply a 9.4% discount rate to both policies, what is the present value of each dividend stream? C. Suppose investors see Policy #2 as the riskier of the two, and they therefore apply a 9.4% discount rate to Policy #1 and a 12% discount rate to Policy #2. Under this scenario, what is the present value of each dividend stream? D. What conclusions can be drawn from this exercise? A Policy #1 Policy #2 Year 1. 2 3 4 Total over five years B Policy #1 9.40% Year Cash Flow PV Factor Present value Present value Policy #2 9.40% Cash Flow PV Factor Present value Year 1. 3 4 5 Present value Policy #1 9.40% Year Cash Flow PV…arrow_forwardYou are considering purchasing a share of preferred stock with the following characteristics: par value = $100 dividend rate = 12% per year payment schedule = quarterly maturity date = required rate of return = 6% per year current market price = $135 per share Based on this information, answer the following: A. What is the dollar amount of the quarterly dividend on this stock? B. Using the Discounted Cash Flow Method, what is the dollar value of this stock? C. Using the Discounted Cash Flow Method, what is the annual expected return for this stock? D. Based on your answer to part B, should you invest in the stock? Why or why not? E.…arrow_forward1. (True or false) Suppose I invested $10,000 in stock A 20 years ago and held that investment (reinvesting dividends, if any) until today. If stock A achieved a positive annual arithmetic rate of return over this 20-year period, then I must have more than $10,000 in my investment in this stock today. 2. (True or false). Short-selling allows investors to benefit from price declines. 3. (True or false). Suppose I hold a portfolio of two assets A and B. 40% of my money is invested in A and the remaining 60% is invested in B. Suppose the risks (return volatility) of A and B are both 10%. Then, the volatility of my portfolio return will also be 10%. 1arrow_forward
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