Chapter
8
•Stock Valuation
McGraw-Hill/Irwin
Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 8 – Index of Sample
Problems
•
•
•
•
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Slide # 02 - 07
Slide # 08 - 17
Slide # 18 - 23
Slide # 24 - 29
Slide # 30 - 37
Slide # 38 - 41
Slide # 42 - 43
Zero growth stock
Constant growth stock
Irregular growth stock
Required return
Preferred stock
Shareholder voting
Stock market reporting
2: Zero growth stock
Rainbow Rentals pays a constant annual dividend of $1.00 per
share on their common stock.
How much are you willing to pay for one share of this stock if you
want to earn a 9% rate of return?
3: Zero growth stock
D
P0 
r
$1.00

.09
 $11.11
4: Zero growth stock
Bits ‘n Pieces pays a constant annual dividend of $.50 a share. The
market price of the stock is $5.41 today.
What is the rate of return on this stock?
5: Zero growth stock
D
P0 
r
$.50
$5.41 
r
$5.41r  $.50
r  .09242
r  9.24%
6: Zero growth stock
The common stock of Kathy’s Antiques, Etc. is priced at $12.50 a
share. The stock provides a 10% rate of return. The company pays
a constant dividend.
What is the amount of the annual dividend?
7: Zero growth stock
D
P0 
r
D
$12.50 
.10
D  $1.25
8: Constant growth stock
JLE, Inc. just paid their annual dividend of $1.10 a share. JLE’s
policy is to increase the dividend by 2% annually.
How much are you willing to pay today for a share of this stock if
you require an 11% rate of return?
9: Constant growth stock
D1 D 0  (1  g)

P0 
rg
r g
$1.10  (1  .02)

.11  .02
$1.122

.09
 $12.46667
 $12.47
10: Constant growth stock
SLG, Inc. announced today that they will be increasing their annual
dividend to $1.60 per share next year. After that, they expect to
increase the dividend by 3% annually. You want to buy shares of
stock in this company but can not afford to do so for another two
years. At that time, you will buy shares if you can earn a 12% rate
of return.
How much will you be willing to pay for one share of this stock two
years from today?
11: Constant growth stock
D t 1
Pt 
rg
D3
D1  (1  g) 2
P2 

rg
r g
$1.60  (1  .03) 2

.12  .03
$1.69744

.09
 $18.86
12: Constant growth stock
Alex’s Ventures, Inc. stock has a 13% rate of return and a current
market price of $16.18. The company pays annual dividends. The
last dividend paid was $1.40 per share.
What is the growth rate of this stock?
13: Constant growth stock
D 0  (1  g )
D1
P0 

rg
rg
$1.40  (1  g )
$16.18 
.13  g
$2.1034  $16.18g  $1.40  $1.40g
$17.58g  $.7034
g  .04001
g  4.00%
14: Constant growth stock
C and F Fabrics is going to pay an annual dividend of $1.36 per
share next week. The dividends have been increasing by 2%
annually and this trend is expected to continue. The stock is
selling for $15.11 per share.
What is the market rate of return on this stock?
15: Constant growth stock
D1
P0 
rg
$1.36
$15.11 
r  .02
$15.11r  $.3022  $1.36
$15.11r  $1.6622
r  .1100
 11.00%
16: Constant growth stock
The Thomas Co. is in a declining industry and has just announced
that they will be reducing their annual dividend by 2% annually
from now on. The last dividend they paid was $1.60. The market
rate of return on this stock is 6%.
What is the market price of one share of Thomas Co. stock?
17: Constant growth stock
D 0  (1  g )
D1
P0 

rg
rg
$1.60  [1  ( .02)]
P0 
.06  ( .02)
.08P0  $1.568
P0  $19.60
18: Irregular growth stock
Isaac’s Shoes just announced that they will commence paying
annual dividends next year. The plan is to pay $.50, $.75 and $1.00
per share over the next three years, respectively. After that the
company plans on increasing the dividend by 2.5% annually. The
market rate of return on this stock is 12.5%.
What should the market price of this stock be?
19: Irregular growth stock
D 4 D3  (1  g)
P3 

rg
rg
$.50
$.75
$1.00  $10.25
P



0
$1.00  (1  .025)
1
2
3
(
1

.
125
)
(
1

.
125
)
(
1
.
125
)

.125  .025
 $.44444  $.59259  $7.90123
$1.025
 $8.93826

 $8.94
.10
 $10.25
20: Irregular growth stock
Nu-Tek, Inc. just paid their annual dividend of $1.20 per share. The
company has stated that dividends will increase by 20% a year for
the next two years. After that, the dividends will increase by 4%
annually.
What is one share of this stock worth today if the required return is
14%?
21: Irregular growth stock
D1  $1.20  (1  .20)  $1.44
D2  $1.20  (1  .20) 2  $1.728
D3
D  (1  g)
 2
rg
r g
$1.728  (1  .04)

.14  .04
$1.79712

.10
 $17.9712
P2 
$1.44
$1.728  $17.9712

(1  .14)1
(1  .14) 2
 $1.26316  $15.15789
P0 
 $16.42105
 $16.42
22: Irregular growth stock
RPJ, Inc. is currently reinvesting all of their earnings back into the
company. They predict that they will pay their first annual dividend
five years from now in the amount of $1.00 per share. After that,
they will increase the dividends by 2% annually.
How much are you willing to pay for one share of this stock today
if you require a 15% rate of return?
23: Irregular growth stock
D6
D 5  (1  g )
P5 

rg
rg
$1.00  (1  .02)

.15  .02
$1.02

.13
 $7.84615
$1.00  $7.84615
P0 
(1  .15) 5
 $4.3981
 $4.40
24: Required return
The common stock of Flo’s Home Furnishings has a 3.5% dividend
yield. You expect the company to grow by 6% annually.
What is the required return on this stock?
25: Required return
D1
r
g
P0
 3 .5 %  6 %
 9 .5 %
26: Required return
The common stock of Roy’s Outdoor Sports Store has a market
rate of return of 17.5% and a market price of $15.00 per share.
Roy’s will pay their annual dividend next week in the amount of
$2.10 per share.
What is the capital gains yield on this stock?
27: Required return
D1
g
r
P0
$2.10
g
.175 
$15.00
.175  .14  g
g  .035
g  3 .5 %
28: Required return
The common stock of Viola’s Flowers, Inc. has a required return of
12.25% and a growth rate of 8%. The stock has a current market
price of $32.94 a share.
What is the amount of the next annual dividend?
29: Required return
D1
r
g
P0
D1
.1225 
 .08
$32.94
D1
.0425 
$32.94
D1  $1.39995
D1  $1.40
30: Preferred stock
The 7% preferred stock of Lamey, Inc. is priced to yield a 12.5%
rate of return.
What is the market price of this stock?
31: Preferred stock
D
P0 
r
.07  $100

.125
$7.00

.125
 $56.00
32: Preferred stock
The 9% preferred stock of Eglon, Inc. is selling at a market price of
$72.00 a share.
What is the market rate of return on this stock?
33: Preferred stock
D
P0 
r
.09  $100
$72.00 
r
$72.00r  $9.00
r  .1250
r  12.50%
34: Preferred stock
The preferred stock of the P ‘n T Co. is selling for $67.26 a share
and provides an 8.55% rate of return.
What is the amount of the preferred dividend per year?
35: Preferred stock
D
P0 
r
D
$67.26 
.0855
D  $5.75073
D  $5.75
36: Preferred stock
The Oil Town Co. pays dividends on their 6% cumulative preferred
stock on an annual basis. The company has not paid this dividend
for the last two years. This year the company is doing better
financially and wants to pay dividends on both their preferred and
their common stock.
What is the minimum amount they must pay per share to their
preferred stockholders before distributing any dividends to their
common stockholders?
Would your answer differ if the preferred stock was noncumulative?
37: Preferred stock
Annual dividend = .06  $100 = $6.00
Minimum due per share to the preferred stockholders:
Cumulative:
$6 + $6 + $6 = $18
Non-cumulative:
$6
38: Shareholder voting
WV & BK, Inc. has 125,000 shares of common stock outstanding.
The company currently has 2 open seats on their board of
directors and uses cumulative voting.
How many shares of stock must you own to ensure your election
to one of the open positions if you doubt that anyone else will vote
for you?
39: Shareholder voting
Number of shares outstandin g
1
Number of open positions  1
125,000

1
2 1
125,000

1
3
 41,666.67  1
Shares needed under cumulative voting 
 41,667  1
 41,668
40: Shareholder voting
Lakeland Industries has 260,000 shares of stock outstanding. The
company currently has three open positions on their board of
directors. These positions will be filled using straight voting.
Currently, you own 85,000 shares of this stock which has a current
market price of $21.40 a share.
How much money must you spend to purchase additional shares if
you want to absolutely guarantee that you will be elected to one of
those three positions? Assume that no one else votes for you.
41: Shareholder voting
Number of shares outstandin g
1
2
260,000

1
2
 130,001
Shares needed for straight v oting 
Cost to purchase additional shares  (130,001 - 85,000)  $21.40
 45,001  $21.40
 $963,021.40
42: Stock market reporting
ABC Co. stock closed today at a price of $48.24. The priceearnings (P/E) ratio is 18 and the dividend yield is 2.1%.
What is the amount of the earnings per share?
What is the amount of the annual dividend?
43: Stock market reporting
P
P/E 
EPS
$48.24
18 
EPS
EPS  $2.68
Dividend
Dividend yield 
Pr ice
D
.021 
$48.24
D  $1.013
D  $1.01
Chapter
8
•End of Chapter 8
McGraw-Hill/Irwin
Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.