# Fin515 Week 4 Homework Solutions

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FIN515 Week 4 Homework 9-1 Future Value of a Company Assume Evco, Inc., has a current price of \$50 and will pay a \$2 dividend in one year, and its equity cost of capital is 15%. What price must you expect it to sell for right after paying the dividend in one year in order to justify its current price? Answer: Find price of stock in 1 year. Current Price = \$50, Dividend = \$2, Cost of Equity Capital = 15% X = Price the stock will sell right after paying the dividend: 50 = (2+ X) /(1+0.15) X = 55.50 Therefore, price the stock will sell right after paying the one year dividend is \$55.5 9-4 Dividend Yield and Cost of Equity Capital Krell Industries has a share price of \$22 today. If Krell is expected to pay a dividend of \$0.88 this year, and its stock price is expected to grow to \$23.54 at the end of the year, what is Krell’s dividend yield and equity cost of capital? Answer: Dividend Yield = Dividend / Share price = 0.88/22 = 4% Capital Gain Rate = (End of year stock price – Share price today) / Share price today = (23.54 – 22) / 22 = 7% Total expected return (Equity cost of capital) = 4% + 7% = 11% 9-5 No Growth Company NoGrowth Corporation currently pays a dividend of \$2 per year, and it will continue to pay this dividend forever. What is the price per share if its equity cost of capital is 15% per year? Answer: Assume: dividends are paid at the end of the year Stock pays a total of \$2.00 in dividends per year. Valuing this dividend as a perpetuity: P = \$2.00 / 0.15 = \$13.33 9-6 Value of Operations of Constant Growth Summit Systems will pay a dividend of \$1.50 this year. If you expect Summit’s dividend to grow by 6% per year, what is its price per share if its equity cost of capital is 11%? Answer: Price per share = 1.50 / (11% – 6%) = \$30