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if you have assumed that both companies’ earnings will grow by 5% a year indefinitely in computing the fair values. Topic: Bond Valuation GROWTH. Both companies’ expected returns are 8%.classof1.’s next year earning is expected to be $4 per share. and grow by 5% a year indefinitely thereafter. In year 6 and afterward. suppose the stock prices computed in (a) are the actual traded prices. Inc. (c) Which stock would you buy using the PEG rule? Now. STABLE. Inc. respectively.Sub: Finance Question: Calculation of Value of Stock.33%.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades. Both dividends and earnings are expected to grow by 10% a year for the first 5 years. . which stock should you buy? www. it will pay out all earnings as dividends. However. is like GROWTH in all respects except that its growth will stop after year 5. (a) What are the stock prices for each company? (b) What are the P/E ratios and PEG ratios for each company? Assuming the average growth rates for GROWTH and STABLE are 6% and 3. The company pays out half of its earning as dividend.

Inc.classof1.9259 0.96 $1.42 $2.20 $2.99 $4 $2 10% 8% B C D E F 10 3 11 4 12 5 www. Earnings per share in Year 1 Dividend per share in Year 2 Dividend growth rate for the first 5 years Expected return Year Dividend PV Factor PV of at 8% 0. .8573 0.66 $2.85 $1.Sub: Finance Topic: Bond Valuation Solution : (a) A 1 2 3 4 5 6 7 8 9 1 2 $2.6806 Dividend $1.93 Growth.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.7938 0.89 $1.92 $1.7350 0.00 $2.

74 Dividend Topic: Bond Valuation $9.5403 0.Sub: Finance 13 PV of dividends up to year 5 14 Dividend growth rate from years 6 to 10 15 Year 16 17 6 18 7 19 8 20 9 21 10 22 Total Value of dividends from years 6 to 10.6302 0.78 $1. .8 25 PV of dividends from years 1 to 10 26 Dividend for year 11 (D11) 27 Dividend growth rate (g) $1.4632 Dividend $1.5002 0.61 5% PV Factor PV of at 8% 0.24 $15.classof1.83 $1.16 $6.73 $9.39 $3.88 $1.5835 0.94 $1.07 $3. as at 23 the end of year 5 24 PV of dividends from years 6 to 10 $3.56 $3.16 $9.82 5% 5 www.23 $3.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.

com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades. 35 Earnings per share in Year 1 36 Dividend per share in Year 2 37 Dividend growth rate for the first 5 years 38 Expected return 39 Year 40 41 1 $2.00 Dividend PV Factor PV of at 8% 0. Inc.9259 Dividend $1.Sub: Finance 28 Required Rate of Return (K) Value of stock at the end of year 10 (P10) = 29 D11/(K-g) Topic: Bond Valuation 8% $60.9 32 33 34 Stable.85 $4 $2 10% 8% 1 www.0 30 PV of P10 Price of Stock = PV of dividends up to 10 31 years + PV of price of stock at year 10 6 $43. .classof1.5 9 $28.

8 53 PV of P5 54 2 Price of Stock = PV of dividends up to 5 years www.42 $2.20 $2.classof1.61 $5.7938 0.92 $1.96 $1.99 $9.93 Topic: Bond Valuation 0.89 $1.7350 0.8 49 Dividend for year 6(D6) 50 Dividend growth rate (g) 51 Required Rate of Return (K) Value of stock at the end of year 5 (P5) = 52 D6/(K-g) 6 0 8% $73.2 1 $49.8 48 Earnings for year 6 6 $5.8 47 Earnings for year 5 6 $5.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.6806 $1.8573 0.Sub: Finance 42 2 43 3 44 4 45 5 46 PV of dividends up to year 5 $2.66 $2. .

08 73 www.1 0.9259/1 =2. Inc.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.08 Dividend =2*0.4 55 3 Excel Workings A 1 2 3 Growth. .08 4 =4/2 B C D E F =0.85 9 2 =2*110% . Earnings per share in Year 1 Dividend per share in Year 2 Dividend growth rate for the first 5 4 5 6 7 8 1 2 years Expected return Year Dividend PV Factor PV of at 8% =1/1.Sub: Finance + PV of price of stock at year 5 Topic: Bond Valuation $59.20*0.9259 0.classof1.

42*0.56*0.5835/1 =3.39*0.93*105% .66*110% .99) =0.08 35 =0.07*105% .6302/1 =3.4938/1 =2.08 50 =0. .23*0.08 02 =0.54 19 8 20 9 =3.6806/1 =3.42*110% .58 18 7 =3.7350/1 =2.Sub: Finance Topic: Bond Valuation =8573/1.5403/1 =3.05 :1.39*105% 03 =0.85 13 PV of dividends up to year 5 Dividend growth rate from years 6 to 14 10 15 Year 16 Dividend PV Factor PV of at 8% Dividend 0.79 10 3 =2.23*105% .0 =2.08 =3.20*110% 8 38 =0.63 17 6 =2.66*0.07*0.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.classof1.68 12 5 =2.50 www.93*0.73 11 4 =2.08 06 =SUM(1.

08.56*105% .classof1.46 21 10 =3.08 (1.5002/1 =3.16/POWER 24 PV of dividends from years 6 to 10 25 PV of dividends from years 1 to 10 =1.16 =9.94: 22 Total Value of dividends from years 6 to 10.05 0. .08 Topic: Bond Valuation 02 =0.5) =9.10) % 0.08.73*105 26 Dividend for year 11 (D11) 27 Dividend growth rate (g) 28 Required Rate of Return (K) Value of stock at the end of year 10 29 (P10) = D11/(K-g) =1.Sub: Finance .61+6. 23 as at the end of year 5 =9.74*0.59/POWE 30 PV of P10 31 R(1.08 32 =SUM(1.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.24 1.82/(8-5) =60.73) Price of Stock = PV of dividends up to 10 years + PV www.

08 Dividend PV Factor PV of at 8% =1/1.66*0.08 Dividend =2*0.8573/1 =2.85 42 2 =2*110% .79 43 3 % .9259/1 =2. 35 Earnings per share in Year 1 36 Dividend per share in Year 2 37 Dividend growth rate for the first 5 years 38 Expected return 39 Year 40 41 1 2 Topic: Bond Valuation =15.08 50 www.08 73 =2. .1 0.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.7938/1 =2.9259 =0.08 38 =2.85+28.Sub: Finance of price of stock at year 10 32 33 34 Stable. Inc.20*0.20*110 =0.42*110 =0.06 4 =4/2 0.classof1.73 44 4 % .42*0.

08 06 =SUM(1.86/(0.68 45 5 % .08.21/POWE 53 PV of P5 Price of Stock = PV of dividends up to 5 years + PV of 54 price of stock at year 5 55 R(1.5) =9.82 (b) www.08 =5.99* 47 Earnings for year 5 48 Earnings for year 6 49 Dividend for year 6(D6) 50 Dividend growth rate (g) 51 Required Rate of Return (K) Value of stock at the end of year 5 (P5) = 52 D6/(K-g) 2 =5.classof1.61+49.93*0.86 0 0.08-0) =73. .86 =5.7350/1 =2.85 46 PV of dividends up to year 5 :1.66*110 =0.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.99) =1.Sub: Finance Topic: Bond Valuation =2.

0333 www. =43. Inc.8 Excel Workings A 57 58 59 60 61 Price of Stock Earnings per share P/E Ratio Average Growth Rate PEG Ratio B Growth. Inc. .06 C Stable.43/4 0. $59. Stable. =59.Sub: Finance A 57 B C Topic: Bond Valuation Growth.91 $4 11.91 4 =43. Inc.43 4 =59.33% 4. Inc.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.9 3.5 58 59 60 61 62 63 Price of Stock Earnings per share P/E Ratio Average Growth Rate PEG Ratio $43.classof1.43 $4 14.0 6% 1.91/4 0.

Sub: Finance 62 63 =11. Stable. Inc. has a high P/E Ratio.2 Excel Workings P/E Ratio Growth. it also has a higher PEG Ratio than Growth.0 Average Growth Rate 5% PEG Ratio 2. Inc.classof1. (d) Growth.9 0.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.9/3. Stable. Inc. one should buy Growth. Therefore.05 www.9 5% 3. Inc. Inc.33 Topic: Bond Valuation (c) A higher PEG Ratio indicates that the stock has been overvalued. =14.0 PEG Ratio 0.0/6 =14. though Stable.05 Average Growth Rate =11. .0 Inc. P/E Ratio 11. 14. which will have a bettr value in future. Inc.

Sub: Finance =11.com/homework-help/finance *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.9/5 Topic: Bond Valuation www. .classof1.0/5 =14.

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GROWTH, Inc.’s next year earning is expected to be $4 per share. The company pays out half of its earning as dividend. Both dividends and earnings are expected to grow by 10% a year for the first 5...

GROWTH, Inc.’s next year earning is expected to be $4 per share. The company pays out half of its earning as dividend. Both dividends and earnings are expected to grow by 10% a year for the first 5 years, and grow by 5% a year indefinitely thereafter. STABLE, Inc. is like GROWTH in all respects except that its growth will stop after year 5. In year 6 and afterward, it will pay out all earnings as dividends. Both companies’ expected returns are 8%.

(a) What are the stock prices for each company?

(b) What are the P/E ratios and PEG ratios for each company? Assuming the average growth rates for GROWTH and STABLE are 6% and 3.33%, respectively.

(c) Which stock would you buy using the PEG rule? Now, suppose the stock prices computed in (a) are the actual traded prices. However, if you have assumed that both companies’ earnings will grow by 5% a year indefinitely in computing the fair values, which stock should you buy?

(a) What are the stock prices for each company?

(b) What are the P/E ratios and PEG ratios for each company? Assuming the average growth rates for GROWTH and STABLE are 6% and 3.33%, respectively.

(c) Which stock would you buy using the PEG rule? Now, suppose the stock prices computed in (a) are the actual traded prices. However, if you have assumed that both companies’ earnings will grow by 5% a year indefinitely in computing the fair values, which stock should you buy?

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