Finance Fundamentals of Finance Assuming Term Paper

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3) a. If $1.25 represents a 40% dividend payout ratio, earnings per share are $3.13. A six percent return (the required return) would put future earnings at $3.32. ((3.32-3.13)*100)/3.13 = 6.07%

b. 40% (the dividend payout ratio) of $3.32 (future estimated earnings) is $1.33

c. The price of the stock cannot be calculated accurately with the information given, however if its is assumed that the earnings per share (currently $3.13 with dividends of $1.25 and a dividend payout ratio of 40%) represent the 20% return on equity, then the price is simply five times the earnings per share, or $15.65.

d. assuming the dividend payout ratio and return on equity remain constant at 40% and 20% throughout this period, a and the same relationship for the ROE and stock price, in the first year, a dividend of $2 means EPS increases to $5, translating to a stock price of $25; four percent dividend growth the following year becomes $2.08, EPS of $5.20, and a stock price of $26.

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The stock price essentially grows at the same percentage as the dividend if these relationships remain constant.

e. A stock price of $30 would still be relatively cheap (a P/E of just under 10) given an industry average of a P/E of 15. This also means that the valuation of the stock using the ROE as the P/E is probably inaccurate, as it suggests a price for the stock that is far cheaper than the industry average.

4) Assuming a $1,000 par value for all bonds discussed,

a. At 9% interest, the price of the zero coupon bond is $649.93. The price of the bond paying an 8% coupon on a semi-annual basis is $960.44.….....

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