Question 1: (Lecture 8)

Suppose common shares of Company A are trading at $1657.00 per share. Company historical dividend yield is 4.05 percent per annum based on expected future price at the end of 12 months period from today. Company recorded capital gains over the past 12 months of 11.3%.

Assume that over the next 12 months, the share price is expected to fall by the same percentage rate as in prior 12 months. What is the price investors will be willing to pay for this stock today, if the discount rate is 5 percent per annum? Is the stock over- or under-valued at $1657.00? How much is it over- or under-valued by?

Now, suppose discount rate that applies to equity markets falls to 0.5 percent, but dividend yield for the next twelve months rises to 7.5%. Is the stock over- or under-valued at $1657.00? How severely?

What are the nominal and real rates of return to be earned from the stock in (a) and (b) above?

Show all calculations for parts (a)-(c).