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# Homework 2

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HOMEWORK #2 ASSIGNMENT Name Juliet Shomaker______ 1. (10%) According to constant growth dividend discount model, we compute the intrinsic value of stock at time 0 (today’s computed stock price), P0=D1/(k-g), where D1 is the expected dividend next year, and k is the required return or discount rate. Assuming the required return is 20% per year. a. If we assume dividend will grow at a constant rate of 8% infinitely. The stock price is \$35 per share.

If we assume the stock is correctly priced, i.

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e. , the stock has intrinsic value equal to its market price, what is the dividend the firm is paying to its shareholders this year? Hint: D1=D0*(1+g). P0=D1/ (k – g) \$35=D1/ (. 20 – . 08) ( D1 = \$4. 20 D1 = D0 * (1 + g) \$4. 20 = D0 * (1 + . 08) ( D0 = \$3. 89 b. Instead of assuming that the firm will have a constant dividend growth ratio of 8%, if we assume that the firm will have ROE (return on asset) of 15% per year, expected EPS (earns per share, E1) of \$2. 0, and the dividend payout ratio of 60%.

Will you buy or sell the stock? D1 = E1 * d D1 = \$2. 50 * . 6 ( D1 = \$1. 50 g = ROE * b g = . 15 * . 4 ( g = . 06 V0 = D1/ (k – g) V0 = \$1. 50/ (. 2 – . 06) ( \$10. 72 ( Sell stock 2. (10%) The FI Corporation’s dividends per share are expected to grow indefinitely by 5% per year: a. If next year dividend is expected to be \$8. 00 and the market capitalization rate is 10% per year, what must the current stock price be according to the DDM?

P0 = D1 / (k – g) P0 = \$8. 00 / (. 10 – . 05) ( \$160. 00 b. If the expected EPS are \$12, what is the implied value of the ROE on future investment opportunity? EPS &gt;ROE d = D1 / E1 d = \$8 / \$12 ( . 6667 b = . 3333 ROE = g / b ROE = . 05 / . 3333 ( . 15 3. (10%) The risk-free rate of return is 10%, the required rate of return on the market is 15%, and High-Flyer stock has a beta coefficient of 1. 5. If the dividend per share expected during the coming year, D1, is \$2. and g=5%, at what price should a share sell? k = rf + (*[E(rm) – rp] k = . 10 + 1. 5*[. 15 – . 1] ( . 175 P0 = D1 / (k – g) P0 = \$2. 50 / (. 175 – . 05) ( \$20. 00 4. (10%). You write a call option with X=\$50 and buy a call with X=\$60. The options are on the same stock and have the same expiration date. One of the calls sells for \$3; the other sells for \$9. What is the break-even point for this strategy? Profit = \$9 – \$3 > \$6 | |ST

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