COMMON STOCKS VALUATION

1. The Kong Skull Company most recent dividend was RM2.50 and this dividend is expected
to grow at 5% year 1; 4% year 2; 5% year 3; 3% year 4 and 5% year 5. After year 5, the
dividend growth rate is expected to increase to 6% per year indefinitely. What is the value
of the stock if the required rate of return is 8%?

D0 = RM2.50
D1 = 2.50 (1.05) = 2.625 (.926 ) = 2.431
D2 = 2.625 (1.04) = 2.73 (.857 ) = 2.340
D3 = 2.73 (1.05) = 2.867 (.794 ) = 2.276
D4 = 2.867 (1.03) = 2.952 (.735 ) = 2.170
D5 = 2.952 (1.05) = 3.100 (.681 ) = 2.111
P5 = 3.100 (1.06)/0.08-0.06 = 164.306 (.681) = 111.892

VCS = 2.431 + 2.340 + 2.276 + 2.170 + 2.111 + 111.892

= RM123.13

2. The most recent dividend of KT shares was RM2.50 and expected to grow at 3 percent
every year for the next 2 years. After which, the dividend will grow at 6 percent every year
indefinitely. Assuming 10 percent required rate of return, what is the value of KT’s share?

[RM2.50(1.03)] (0.909) = RM2.341

[RM2.575 (1.03)] (0.826) = RM2.191
[RM2.652(1.06) /(10%-6%)](0.826) = RM58.055
RM2.341 + RM2.191 + RM58.055 = RM62.58

3. En Kay Berhad (EKB) has an expected dividend next year of RM5.60 per share. The
dividend is expected to grow at 10 percent for an unforeseeable future. What is the value
of EKB common stock if the required return is 20 percent?

RM5.6/(20% -10%) = RM56.00

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4. The current dividend on a stock is $2 per share and investors require a rate of return of
12%. Dividends are expected to grow at a rate of 3% in year 1; 6% in year 2; 4% in year
3 and then at a rate of 5% per year forever. Find the intrinsic value of the stock.

D1 = $2.00(1+0.03) = $2.06
D2 = $2.06(1+0.06) = $2.18
D3 = $2.18(1+0.04) = $2.27
P3 = D4/(Kcs –g)
=$2.38/(12% -5%)
= $34
P0 = $2.06(0.8929) + $2.18(0.7972) + $2.27 (0.7118) + $34 (0.7118)
= $1.84 + $1.74 + $1.62 + $24.20
= $29.40

5. A stock with a required rate of return of 10 percent sells for $30 per share. The
stock’s dividend is expected to grow at a constant rate of percent per year. What is the
expected year- end dividend, D1, on the stock?

$30 = D1/(0.10 – 0.07)

$30 = D1/0.03
D1 = $0.90

6. Allegheny Publishing’s stock is expected to pay a year-end dividend, D1, of $4.00.

The dividend is expected to grow at a constant rate of 8 percent per year, and the stock’s
required rate of return is 12 percent. Given this information, what is the expected price of
the stock, eight years from now?

$4/(0.12 – 0.08) = $100

If the growth rate is 8%, the price in 8 years from now will be
$100(1+0.08)8 = $185.09

7. Antiques ‘R’ Us is a mature manufacturing firm. The company just paid a $7 dividend,
but management expects to reduce the growth rate by 5 percent per year, indefinitely. If you
require a 10 percent return on this stock, what will you pay for a share today?

P0 = D0 (1 + g) / k –
g)
P0 = $7.00(1 – .05) / [(.10 – (–.05)]

P0 = $6.65 / .15

P0 = $44.33

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8. Barnard Corp. will pay a dividend of $3.05 next year. The company has stated that it
will maintain a constant growth rate of 5 percent a year forever.

a. How much will you pay for the stock if a required rate of return is 15%?

P0 = D1 / (R – g)

P0 = $3.05 / (.15 – .05)

P0 = $30.50

b. What if you want a 10 percent rate of return?

P0 = D1 / (R – g)

P0 = $3.05 / (.10 – .05)

P0 = $61.00

c. What does this tell you about the relationship between the required return and the
stock price?

All else held constant, a higher required return means that the stock will sell for a lower
price. Also, notice that the stock price is very sensitive to the required return. In this
case, the required return fell by 1/3 (15% to 10%) but the stock price doubled ($30.50
to $61.00).

9. A stock you are evaluating paid a dividend at the end of last year of $3.50. Dividends
have grown at a constant rate of 2 percent per year over the last 20 years, and this constant
growth rate is expected to continue forever. The required rate of return on the stock is 10
percent. What is the price for the stock?

P0 = [$3.50 (1+0.02)] / (0.10 – 0.02)

=$44.63

10. Stability Inc. has maintained a dividend rate of $4.50 per share for many years. The
same rate is expected to be paid in future years. If investors require an 11% rate of
return on similar investments, determine the present value of the company’s stock.

This is a problem with constant growth equal to 0, so the formula becomes merely
dividend divided by the required return.

$4.50 / .11 = $40.91

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11. Cosy Bhd common stock has just paid a dividend of RM1.32 and is expected to
grow indefinitely at an annual 7 percent rate. What is the value of the stock if you require
an 11 percent return?

Vcs = [ $1.32 (1.07)] / (0.11 – 0.07)

= $35.31

12. Black & White Co. common stock currently sells for RM23 per share. The
company’s executives anticipate a constant growth rate of 10.5 percent and an end of
year dividend of RM2.50.
a. What is your expected rate of return?

Kcs =( $2.50/$23 ) + 0.105

= 0.2137
=21.37%

b. If you require a 17 percent return, will you purchase the stock? Why?

Yes, buy because 21.37% > 17%

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 PREFERRED STOCKS VALUATION

1. Mr. D recently purchased a block of 100 shares of Pak Atan’s Farming Corporation
preferred stocks for RM6,000. The stocks are expected to provide an annual cash flow of
dividends of RM400. Did Mr. D make a right choice by purchasing these stocks if the
required rate of return is 8 percent?
Market Price = RM6000/100 shares
= RM60
D1 = RM400/100 shares = RM4
Expected Return = D1/PO
=RM4/RM60
= 6.6%
OR
D1/k = RM4/0.08
=RM50
No, since Expected Return (6.6%) < Required rate of return (8%),
OR
Intrinsic Value (RM50) < Market price (RM60)

2. Greenfield Inc.’s preferred stock is currently selling for RM25 per share. If the company
promises to pay RM3 annual dividends, what is your expected return from the purchase of
this stock?
RM3/RM25 = 12%

3. What is the value of a preferred stock where the dividend rate is 16 percent on a
RM100 par value? The appropriate discount rate for a stock of this risk level is 12 percent.

Vps = 0.16($100) / 0.12

= $133.33

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4. You own 250 shares of Dalta Bhd’s preferred stock, which is currently selling for
RM38.50 per share and pays quarterly dividend of RM1.25 per share.
a. What is the expected rate of return?

Kps = [$1.25 (4)] / $38.50

= 12.99%

b. If you require an 8 percent return, will you buy more stock or sell the stock,
given the current price? Why?

Buy, because 12.99% > 8%

5. You are considering a preferred stock where the dividend is 14 percent on a

RM100 par value. Calculate the following.
a. The fair value of the preferred stock if you require a return of 7
percent.

Vps = 0.14($100) / 0.07

= $200

b. The expected rate of return if the current market price is

RM189.80.

Kps = $14/$189.80
= 0.0738
=7.38%

Undervalued
$200 > $189.80
7.38%>7%