"Dividend" ed We Stand - Gordon Growth Model for Dividends Part 2 This assignment is a continuation of the last one. Questions A through D provide context; you do not need to answer them again. Your answers are due at the start of class; bring a hard copy and show your calculations for full credit. LewCo, a construction company, pays an annual dividend to the stock owners on the last day of each year. LewCo paid a dividend of $10 per share on December 31, 2019 (ex-date). LewCo increased the dividend by 6% per year since the company started in 1958 . A. Today is January 1,2020 , and the stock price is $400 per share. What expected return (r, discount rate, cost of capital) are investors attaching to LewCo based on the Gordon Growth Model? 8.65\% B. Based on the model, what will be the stock price on January 1, 2021 (one year in the future)? Remember that the company pays a dividend on December 31 of each year; your answer should be the value after the dividend payment on December 31, 2020. $424.00 Assume an investor purchased $100,000 of LewCo stock on January 1, 2020, and liquidated (sold) it a year later on January 2, 2021, after receiving the dividend payment. C. What is the investor's price return or capital gain? State your answer in dollars and cents, for example, $12,345.67. 250 shares; $24.00 price appreciation per share; $6000.00(6% of $100,000),g=6% D. What is the investor's total return? State your answer in dollars and cents, for example, $12,345.67. 250 shares; $24.00 price appreciation plus $10.60 dividend; $8,650(8.65% of $100,000),r=8.65% 1. Paula Worth, a private wealth advisor, saw your analysis of the LewCo cost of capital and future price (questions A \& B above). She approaches you with an idea to lever the $100,000 investment so that you can purchase twice the shares of stock. She proposes to structure the investment as follows: - Buy 250 shares of stock using the $100,000. - Pledge the shares as collateral to secure a loan of another $100,000. - Buy another 250 shares using the loan proceeds; thus, the investor will own a total of 500 shares of stock. - The next annual dividend payment will be $5,300, and payments will grow by 6% per year, as originally assumed. Paula suggests that you calculate the present value of the stream of dividends using the r from question B. She says that process creates value because the present value of the levered investment exceeds the original $100,000 invested. Calculate the present value of the levered dividend stream, and explain if Paula is correct that the leverage created value. 2. This question is a continuation of parts C and D above. The tax on long-term capital gains is 15%, and the tax on regular income is 35%. Half of the dividend qualifies for long-term capital gains treatment; the remainder is regular income. The investor held the stock for more than a year (barely), so she receives long-term capital gains on the price appreciation. What is the after-tax total return (price appreciation plus dividend minus taxes)? 3. LewCo announces early on the morning of January 1, 2020 (after the 2019 dividend payment) that the recent housing crash and subsequent regulatory changes have reduced demand for their construction projects, resulting in a shift in their earnings outlook and dividend policy. They announce that they plan to hold their dividend constant at $10 per year for the foreseeable future. What should be the value of the company after the announcement? Assume that the company's riskiness is unchanged and use your prior estimate of the discount factor from question A. 4. You believe the housing market will recover, and LewCo will resume growing its dividend. What is the company's value assuming dividend growth is zero for three years and then increases again at 6% per year? Continue using the discount factor from question A. Hint: you might want to separate the company's value into two pieces: the value for year four and beyond plus the value of the first three years. 5. My wife Enid will receive a pension of $80,000 per year starting in 10 years; The pension will make payments for 40 years. Use the perpetuity formula and a discount rate of 7% to calculate the present value of the pension. "Dividend" ed We Stand - Gordon Growth Model for Dividends Part 2 This assignment is a continuation of the last one. Questions A through D provide context; you do not need to answer them again. Your answers are due at the start of class; bring a hard copy and show your calculations for full credit. LewCo, a construction company, pays an annual dividend to the stock owners on the last day of each year. LewCo paid a dividend of $10 per share on December 31, 2019 (ex-date). LewCo increased the dividend by 6% per year since the company started in 1958 . A. Today is January 1,2020 , and the stock price is $400 per share. What expected return (r, discount rate, cost of capital) are investors attaching to LewCo based on the Gordon Growth Model? 8.65\% B. Based on the model, what will be the stock price on January 1, 2021 (one year in the future)? Remember that the company pays a dividend on December 31 of each year; your answer should be the value after the dividend payment on December 31, 2020. $424.00 Assume an investor purchased $100,000 of LewCo stock on January 1, 2020, and liquidated (sold) it a year later on January 2, 2021, after receiving the dividend payment. C. What is the investor's price return or capital gain? State your answer in dollars and cents, for example, $12,345.67. 250 shares; $24.00 price appreciation per share; $6000.00(6% of $100,000),g=6% D. What is the investor's total return? State your answer in dollars and cents, for example, $12,345.67. 250 shares; $24.00 price appreciation plus $10.60 dividend; $8,650(8.65% of $100,000),r=8.65% 1. Paula Worth, a private wealth advisor, saw your analysis of the LewCo cost of capital and future price (questions A \& B above). She approaches you with an idea to lever the $100,000 investment so that you can purchase twice the shares of stock. She proposes to structure the investment as follows: - Buy 250 shares of stock using the $100,000. - Pledge the shares as collateral to secure a loan of another $100,000. - Buy another 250 shares using the loan proceeds; thus, the investor will own a total of 500 shares of stock. - The next annual dividend payment will be $5,300, and payments will grow by 6% per year, as originally assumed. Paula suggests that you calculate the present value of the stream of dividends using the r from question B. She says that process creates value because the present value of the levered investment exceeds the original $100,000 invested. Calculate the present value of the levered dividend stream, and explain if Paula is correct that the leverage created value. 2. This question is a continuation of parts C and D above. The tax on long-term capital gains is 15%, and the tax on regular income is 35%. Half of the dividend qualifies for long-term capital gains treatment; the remainder is regular income. The investor held the stock for more than a year (barely), so she receives long-term capital gains on the price appreciation. What is the after-tax total return (price appreciation plus dividend minus taxes)? 3. LewCo announces early on the morning of January 1, 2020 (after the 2019 dividend payment) that the recent housing crash and subsequent regulatory changes have reduced demand for their construction projects, resulting in a shift in their earnings outlook and dividend policy. They announce that they plan to hold their dividend constant at $10 per year for the foreseeable future. What should be the value of the company after the announcement? Assume that the company's riskiness is unchanged and use your prior estimate of the discount factor from question A. 4. You believe the housing market will recover, and LewCo will resume growing its dividend. What is the company's value assuming dividend growth is zero for three years and then increases again at 6% per year? Continue using the discount factor from question A. Hint: you might want to separate the company's value into two pieces: the value for year four and beyond plus the value of the first three years. 5. My wife Enid will receive a pension of $80,000 per year starting in 10 years; The pension will make payments for 40 years. Use the perpetuity formula and a discount rate of 7% to calculate the present value of the pension