 # Equity Valuation

A stock is not expected to pay dividends until three years from now. The dividend is then expected to be \$2.00 per share, the dividend payout ratio is expected to be 40 percent, and the return on equity is expected to be 15 percent. If the required rate of return is 12 percent, the value of the stock today is closest to: a.\$42.36 b.\$47.45 c.\$53.15 d.\$66.67

2/(12%-15%*0.6)=66.7 wrp to period 2 66.7/1.12^2=53.15 wrp to period 0 so answer is C

g= .6* 15= 9%. 2/1.12 + 2*1.09/ 12-9 = 74.67 (in time 3) PV0 = 53.15

66.67/1.12^3 = 47.45. B

D3/ (k - g) = P2 2.00/( (0.12) - (0.6*0.15) ) = 66.67 P2 = 66.67 P0 = 66.67 (1.12^2) = 53.15 P0 = 53.15

Since the dividend is paid three years from the present, shouldn’t it be discounted back three years? Is the correct answer B?

i believe the right answer is C

you shoud take into account that the dividend considered is next years dividend cielito summarized well that if you use D3 then you have the P2 price

Oh thats right… Thanks Florinpop. florinpop Wrote: ------------------------------------------------------- > you shoud take into account that the dividend > considered is next years dividend > cielito summarized well that if you use D3 then > you have the P2 price I beg to differ. Its not D3 its D4…“not expected to pay dividends until three years from now” i would say the answer is B. Dinesh can you confirm?

reema, the correct answer is C correctly solved by cielito, maparam and singlesong80 - Dinesh S

i thought that these were the easy type of questions. I feel miserable The worst is that i still cannot think it right, even with the correct solution posted over and over again :((((

P2 = D3 / K - G D3 = 2 G = .09 K = .12 P2 = 66.67 n = 2 1/y = 12 fv = 66.67 pv = 53.14 *******the only thing I’m confused about is: why I/Y = 12, which is required return of market. I would think to use G, which is the growth rate… any thoughts?

the answer is C… yancey, well, the dividend is not actually paid until 3 years from now… so, in order to PV the price of the stock, you wouldn’t take G into account… just think about how we calculated G… we used the dividend payout ratio, which doesnt come into effect until year 3… so the only rate of return that we have over the first two periods is k, the required return on the market…