 # Exam2,morning, question14, WHY???

Question ID#: 50794 Exam2, morning, QUESTION 14 Look at the answer below. Why is it \$2.74 / (0.08 ¨C 0.04). I dont understand the 0,08. I thought it would be 0,072 ??? What am I missing??? Please explain!!! ---------- The answer: The value of the stock in early 2008 is the present value of the future dividends. After 2010, dividends are expected to grow at the rate of 4%. The dividend that begins the constantly growing perpetuity is \$2.63 ¡Á 1.04 = \$2.74. The appropriate discount rate is the cost of equity of 7.2% from Question 13. Note that for the third cash flow, we add the third dividend (\$2.63) to the present value of the constantly growing perpetuity that begins in the fourth year = \$2.74 / (0.08 ¨C 0.04) = \$68.50. This is valid since they both occur at the same point in time (i.e., at the end of the third year). Using a financial calculator we can estimate the value of one share of O¡¯Connor stock as follows: CFO = 0; C01 = \$2.13; C02 = \$2.36; C03 = \$2.63 + \$68.50 = \$71.13; I = 7.2; CPT ¡ú NPV = \$61.78 (Study Session 12, LOS 46.h)

Check the erratta. They left out a piece of data.

Yeah, that seems to be an error. I was thrown off by that too. They are using two different required return values. Has to be an errata item.

It is. You have to assume 8%.

thanks - I lost minimum 20 minutes on that one and I couldn’t make q15 either because of that… Wow - I’m happier now!