fin homework 6

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a) Explain the preemptive right.

b) What is the classified stock?

Refer to the following examples for part c) and d)

A firm is expected to pay a $2 dividend per share next year and its dividend is expected to grow at a constant rate of 6% per year. If the required rate of return on the firm’s stock is 10%, what is the firm’s stock price (or intrinsic price) today?

Because the dividend has a constant growth rate from the next year, the constant growth model can be used. According to the constant growth model,

Stock price (intrinsic price) today = the next year’s dividend per share / (required rate of return – dividend growth rate) = $2/(0.1 – 0.06) = $50.

A firm has just paid a $1.5 dividend per share. If the required rate of return is 12% and the constant growth rate is 5%, what is the stock price (intrinsic price) today?

$1.5 dividend is today’s dividend, not the next year’s. So, we need the next year’s dividend to use the constant growth model. Since the dividend grows at a 5% constant rate, the next year’s dividend should be 1.5*(1+.05) = $1.58 (=> Actually this is the future value of today’s dividend)

Then, the stock price today = 1.58/(.12 – .05) = $22.57

c) Suppose that Troy Inc. has just paid a $3 dividend per share. If the required rate of return is 15% and the dividend is expected to grow at a constant rate of 4%, what is the stock price today?

d) BMC is expected to pay a $1 dividend per share next year. If the stock price today is $20, what is the required rate of return? Assume that the dividend is expected to grow at a constant growth rate of 3%.

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