BUAD 306 Fall 2015 Professor Cary Frydman Practice Problems 4 Answers Posted Monday October 5th Assignments must be submitted electronically via Blackboard either typed or hand written and scanned Working in groups is encouraged but each group member must submit his or her own separate write up 1 Based on the dividend growth model what are the two components of the total returns on a share of stock Which do you think is typically larger 2 XYZ Corp pays a constant 2 50 annual dividend on its stock The company will maintain this dividend for the next 11 years and then will cease paying dividends forever If the required return on this stock is 10 percent what is the current share price 3 GP Farms just paid a dividend of 3 20 on its stock The growth rate in dividends is expected to be a constant 5 percent per year indefinitely Investors require a return of 15 percent for the first three years a return of 13 percent for the next three years and a return of 11 percent thereafter What is the current share price HINT There are three components to the price two growing annuities and a growing perpetuity 4 Red Inc Yellow Corp and Blue Co each will pay a dividend of 2 65 next year The growth rate in dividends is 8 11 and 14 respectively The required return for each company s stock for all three companies is 15 percent What is the stock price for each company What do you conclude about the relationship between the growth rate and the stock price 5 An investment project provides cash inflows of 585 per year for 8 years What is the project payback period if the initial cost is 1 700 What if the initial cost is 3 300 What if it is 4 900 Assume cash inflows are evenly spread over the year and calculate a fractional year in the payback time if necessary 6 What is the IRR of the following set of cash flows YEAR CASH FLOW 0 56 400 1 2 3 7 100 8 400 6 900 7 For the cash flows of the previous problem what is the NPV at a discount rate of zero percent What if the discount rate is 10 percent If it is 20 percent If it is 30 percent 8 What is the profitability index for the following set of cash flows if the relevant discount rate is 10 What is the discount rate is 15 If it is 22 YEAR CASH FLOW 0 18 000 1 10 300 2 9 200 3 5 700
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