# Finance Questions-8

15. Constant-Growth Model. A stock sells for $40. The next dividend will be $4 per share. If the rate of return earned on reinvested funds is a constant 15% and the company reinvests a constant 40% of earnings in the firm, what must be the discount rate? (LO7-2)

16. Constant-Growth Model. Gentleman Gym just paid its annual dividend of $3 per share, and it is widely expected that the dividend will increase by 5% per year indefinitely. (LO7-2)

a. What price should the stock sell at? The discount rate is 15%

.b. How would your answer change if the discount rate was only 12%? Why does the answer change?

17. Constant-Growth Model. Eastern Electric currently pays a dividend of $1.64 per share and sells for $27 a share. (LO7-2)

a. If investors believe the growth rate of dividends is 3% per year, what rate of return do they expect to earn on the stock?

b. If investors’ required rate of return is 10%, what must be the growth rate they expect of the firm?

c. If the sustainable growth rate is 5% and the plowback ratio is .4, what must be the rate of return earned by the firm on its new investments?

18. Constant-Growth Model. You believe that the Non-Stick Gum Factory will pay a dividend of $2 on its common stock next year. Thereafter, you expect dividends to grow at a rate of 6% a year in perpetuity. If you require a return of 12% on your investment, how much should you be prepared to pay for the stock? (LO7-2)

1.Stock Market History. Use the data in Tables 11.1 and 11.4 to answer these questions: (LO11-1)

a. What was the average rate of return on large U.S. common stocks from 1900 to 2017?

b. What was the average risk premium on large stocks?

c. What was the standard deviation of returns on the market portfolio?

2. Maturity Premiums. Investments in long-term government bonds produced a negative average return during the period 1977–1981. How should we interpret this? Did bond investors in 1977 expect to earn a negative maturity premium? What do these 5 years of bond returns tell us about the normal future maturity premium? (LO11-1)

3. Risk Premiums. What will happen to the opportunity cost of capital if investors suddenly become especially conservative and less willing to bear investment risk? (LO11-1)

4. Risk Premium. If the stock market return next year turns out to be −20%, will our estimate of the “normal” risk premium increase or decrease? Does this make sense? (LO11-1)

5. Risk Premiums and Discount Rates. Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will pay a dividend at year-end of $2. What price should she be willing to pay for the stock today? Assume that risk-free Treasury securities currently offer an interest rate of 2%. Use Table 11.1 to find a reasonable discount rate. (LO11-1)

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