6. Expected returns, dividends, and growth Aa Aa The constant growth valuation formula has dividends in the numerator. Dividends are divided by the difference between the required return and dividend growth rate as follows: D1 PO (rs-g) If you were analyzing the consumer goods industry, for which kind of company in the industry would the constant growth model work best? All companies Young companies with unpredictable earnings Mature companies with relatively predictable earnings Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $1.25 at the end of the year. Its dividend is expected to grow at a constant rate of 9.00% per year. If Walter's stock currently trades for $14.00 per share, what is the expected rate of return? 9.89% 9.08% 17.93% 12.53% Which of the following conditions must hold true for the constant growth valuation formula to be useful and give meaningful results? The company's stock cannot be a zero growth stock. The required rate of return, rs, must be greater than the long-run growth rate. The company's growth rate needs to change as the company matures. 7. Constant-growth rates Aa Aa One of the most important components of stock valuation is a firm's estimated growth rate. Financial statements provide the information needed to estimate the growth rate. Consider this case: Robert Gillman, an equity research analyst at Gillman Advisors, believes in efficient markets. He has been following the mining industry for the past 10 years and needs to determine the constant-growth rate that he should use while valuing Pan Asia Mining Co. Robert has the following information available: Pan Asia Mining Co.'s stock (Ticker: PAMC) is trading at $17.50. The company has forecasted net income and book value of equity for the coming year to be $1,104,600 and $8,645,000, respectively. The company has also been paying dividends for the past 8 years and has maintained a dividend payout ratio of 35.00%. Based on this information, Robert's forecast of PAMC's qrowth rate in earnings and dividends should be: 8.31% 22.37% 6.71% 19.17% Which of the following statements accurately describes the relationship between earnings and dividends when all other factors are held constant? O Long-run earnings growth occurs primarily because firms pay dividends to reward their shareholders for investing in the company Retaining a higher percentage of earnings will result in a higher growth rate. Growth in earnings requires growth in dividends. 8. Valuing preferred stock Aa Aa Companies that have preferred stock outstanding promise to pay a stated dividend for an infinite period. Preferred stock is treated like a perpetuity if the payments last forever. Preferred stocks are considered to be a hybrid of a stock and a bond. For example, one of the major differences between preferred shares and bonds is that the issuing companies can suspend the payment of their preferred dividends without throwing the company into bankruptcy. However, similar to bonds, preferred stockholders receive a fixed payment-their dividend-before the company's residual earnings are paid out to its common stockholders and, as with common stock, preferred stockholders can benefit from an appreciation in the value of the firm's stock securities. Consider the following case of Lancashire Railway Company (LRC): Lancashire Railway Company (LRC) pays an annual dividend rate of 8.20% on its preferred stock that currently returns 10.99% and has a par value of $100.00 per share. Wwhat is the value of LRC's preferred stock? $100.00 per share $111.92 per share $89.53 per share $74.61 per share Suppose that due to high inflation, interest rates rise and pull the preferred stock's yield to 14.29%. The value of the preferred stock will