Copyright

1. Holtzman Clothiers' stock currently sells for $19 a share. It just paid a dividend of $2 a...

Question:

1. Holtzman Clothiers' stock currently sells for $19 a share. It just paid a dividend of $2 a share (i.e., D0 = $2). The dividend is expected to grow at a constant rate of 4% a year.

a. What stock price is expected 1 year from now? Round your answer to two decimal places.

b. What is the required rate of return? Round your answers to two decimal places. Do not round your intermediate calculations.

2. Preferred stock valuation :

Earley Corporation issued perpetual preferred stock with a 9% annual dividend. The stock currently yields 6%, and its par value is $100.

a. What is the stock's value? Round your answer to two decimal places.

b. Suppose interest rates rise and pull the preferred stock's yield up to 12%. What is its new market value? Round your answer to two decimal places.

Dividends

Dividends refer to the distribution of part of the earnings of a company to its shareholders (preference shareholders and equity shareholders). The company can make the dividend payment either in the form of cash or stock.

Answer and Explanation:

1.

"Given"

  • Current selling price of a share = $19 (P0)
  • Dividend amount = $2 (D0)
  • Dividend growth rate = 4% year (g)

a and b. The stock price is expected 1 year from now (P1) and the required rate of return:

To calculate the stock price (P1) expected 1 year from now and the required rate of return, we use the below formula:

{eq}P0 = D0(1+g)\div (r-g) {/eq}

where,

  • P = price of the stock
  • D0 = current dividend value
  • g = dividend growth rate
  • r = rate of return

Let us calculate first the rate of return using the above formula:

{eq}$19 = $2 (1+ 4 percent )\div (r-4 percent) {/eq}

{eq}$19 = $2 (1.04)\div (r-0.04) {/eq}

= $19 (r-0.04) = $2.08

= $19r - 0.76 = $2.08

= $19r = 2.84

r = 0.1495 = 14.95%

So the required rate of return = 14.95%


Now let us calculate the stock price (P1) expected 1 year from now using the same formula as above:

{eq}P1 = D1(1+g)\div (r-g) {/eq}

P1 = 2.08 (1+4%)\div (14.95% - 4%)

P1 = 2.1632\div 0.1095

P1 = 19.7553 = $19.76

So the stock price (P1) expected 1 year from now = $19.76


2. Preferred stock valuation :

Earley Corporation issued perpetual preferred stock with a 9% annual dividend. The stock currently yields 6%, and its par value is $100.

"Given"

  • Preferred share par value = $100
  • Preferred dividend per share (Dp) = 9% = $100 * 9% = $9
  • Current yield or the required rate of return of Preferred share (Rp) = 6% = 0.06


a. The stock's value:

The stock value is calculated using the formula:

{eq}\text {Stock value} (Vp) = Dp\div Rp {/eq}

{eq}= $9 \div 0.06 {/eq}

= $150

So the stock's value = $150


b. Suppose interest rates rise and pull the preferred stock's yield up to 12%, so the new market value:

So Rp = 12%

{eq}\text {Stock value} (Vp) = Dp\div Rp {/eq}

{eq}= $9\div 12 \text{percent} {/eq}

= $75

So the new market value with new interest rate of 12% = $75


Learn more about this topic:

Loading...
Cash Dividends & Dividend Payment

from Finance 101: Principles of Finance

Chapter 16 / Lesson 1
5.1K

Related to this Question

Explore our homework questions and answers library