1) The Fi corporation Dividends per share are expected to grow indefinitely by 5% per year.

a) If this year ‘s year end dividend is $8 and the market capitalization rate is 10% per year,
what must the current stock price be according to the DDM
b) If the expected Earnings per share is $12 ,what is the implied value of ROE on future
investment opportunities
c) How much is the market paying per share for growth opportunities ( that is for ROE on
future investments that exceeds the market capitalization rate)

D1 $8
P0 = = =$ 160
Ans. a. k−g 0 . 10−0 . 05

b. The dividend payout ratio is 8/12 = 2/3, so the plowback ratio is b = 1/3. The implied
value of ROE on future investments is found by solving:
g = b ´ ROE with g = 5% and b = 1/3  ROE = 15%

c. Assuming ROE = k, price is equal to:

E1 $ 12
P0 = = =$ 120
k 0 .10
Therefore, the market is paying $40 per share ($160 – $120) for growth opportunities

2) The stock of Nogro corporation is currently selling for $10 per share .Earnings per share in
the coming year are expected to be $2.The company has a policy of paying 50% of its
earnings each year as dividends. The rest is retained and invested in projects that earn 20%
rate of return per year. This situation is expected to continue indefinitely
a) Assuming the current market price of the stock reflects its intrinsic value as computed
using the constant growth DDM, what rate of return do Ngoro’s investors require
b) By how much does its value exceed what it would be if all earnings were paid as
dividends
c) If Nogro were to cut its Dividend pay-out ratio to 25%, what would happen to its stock
price. What if Nogro eliminated the dividend

Ans. a. k = D1/P0 + g
D1 = 0.5 ´ $2 = $1
g = b ´ ROE = 0.5 ´ 0.20 = 0.10
Therefore: k = ($1/$10) + 0.10 = 0.20 = 20%

b. Since k = ROE, the NPV of future investment opportunities is zero:

E1
PVGO=P0 − =$ 10−$ 10=0
k
 c.Since k = ROE, the stock price would be unaffected by cutting the dividend and
investing the additional earnings.

3) The risk free rate of return is 8% ,the expected rate of return on the market portfolio is
15%and the stock of Xyrong corporation has a beta coefficient of 1.2. Xyrong pays out 40%
of its earnings in dividends and the latest earnings announced were $10 per share. Dividends
are just paid and are expected to be paid annually. You expect that Xyrong will earn an ROE
of 20% per year on all the reinvested earnings forever
a) What is the intrinsic value of a share of Xyrong stock
b) If the market price of a share is currently $100 and you expect the market price to be
equal to the intrinsic value 1 year from now , what is your expected 1 year holding
period return on Xyrong stock

Ans. a. k = rf + b [E(rM ) – rf ] = 8% + 1.2(15% – 8%) = 16.4%

g = b ´ ROE = 0.6 ´ 20% = 12%
D 0 (1+g ) $ 4×1. 12
V 0= = =$ 101. 82
k−g 0 . 164−0. 12

b. P1 = V1 = V0(1 + g) = $101.82 ´ 1.12 = $114.04

−¿ P $ 4 . 48+$ 114 . 04−$ 100
0
E(r )=D1 +P1 = =0 . 1852=18 . 52% ¿
P0 $ 100
4) The DEQS Corporation pays no cash dividends currently and is not expected to for the next 5
years. Its latest EPS was $10 all of which was reinvested in the company. The firm’s expected
ROE for the next 5 years is 20% per year and during this time it is expected to continue to
reinvest all of its earnings. Starting in year 6 , the firm’s ROE on new investments is expected
to fall to 15% and the company is expected to start paying out 40% of its earnings in cash
dividends, which it will continue to do forever after. DEQS market capitalization rate is 15%
per year
a) What is your estimate of DEQS intrinsic value per share
b) Assuming the current market price is equal to its intrinsic value , what do you expect to
happen to its price over the next year and the year after
c) What effect would it have on your estimate of DEQS intrinsic value if you expect DEQS to
pay out only 20% of its earnings starting in year 6
Ans.

Time: 0 1 5 6
Et $10.000 $12.000 $24.883 $29.860
Dt $0.000 $0.000 $0.000 $11.944
b 1.00 1.00 1.00 0.60
g 20.0% 20.0% 20.0% 9.0%

D6 $ 11 . 944
V 5= = =$ 199. 07
a. k−g 0 .15−0 . 09
 V5 $ 199 . 07
V 0= 5
= =$ 98 . 97
(1+k ) 1 . 155

b. The price should rise by 15% per year until year 6: because there is no dividend, the entire
return must be in capital gains.

c.The payout ratio would have no effect on intrinsic value because ROE = k.

5) The Commonwealth Corporation’s earnings and dividends have been growing at the rate of
12% per annum. This growth rate is expected to continue for 4 years. After that the growth
rate would fall to 5% forever. If the last dividend was $1.5 and the investor’s required rate of
return is 14%, what is the intrinsic value per share of Commonwealth Corporation
6)
7) The following projections have been developed for Omega Limited
Rs. in million
Particulars 1 2 3 4 5
PAT 60 75 72 80 90
Preference 2 2 - - -
dividend
Fixed 300 360 380 410 440
assets
( Net)
Investment 40 20 - - -
s
Net Current 80 100 110 120 130
Assets
Debt 200 250 260 280 300

The cost of Equity for Omega limited is 16% and the constant growth rate after 5 years is 12%
indefinitely. Calculate the Value of Equity using FCFE Model