QUESTION 2 HAS ONE PART FOR A TOTAL OF 8 MINUTES.

In mid-December 2001, Jim Vala has another meeting with Bill Jones.

During the meeting, Jones says:

As you know, Jones Group has recently divested DCom. At the time of that transaction,

we signed a 20-year lease that gives DCom access to our pipeline property. We have just

been informed that, as a result of current market conditions, DCom will default on the

lease payments. We need that cash to service the debt that was retained by Jones Group

at the time of the divestiture.

Jones continues:

We should consider a new dividend policy to conserve cash. Dividends per share will

total $1.85 in 2001. I think we should reduce our dividend by 60 percent and maintain

that lower level for 2002 and 2003 to allow us to pay off some debt. In 2004, we will

increase our dividend back to $1.85, then grow the dividend at 8 percent annually

thereafter.

The required rate of return on Jones Group equity is 11 percent for the foreseeable future.

Calculate, using a dividend discount model (DDM) approach, the expected share price of Jones

Group equity on January 1, 2002, given the new dividend policy described by Jones. Show your

calculations.

(8 minutes)

Dividend Practice Question

Beth Knight, CFA, and David Royal, CFA, are independently analyzing the value of Bishop, Inc. stock. Bishop paid a dividend of $1 last year. Knight expects the dividend to grown by 10% in each of the next 3 years after which it will grow at a constant rare of 4% per year. Royal also expects temporary growth grate of 10% followed by a constant growth rate of 4%, but he expects the supernormal growth to last for only 2 years. Knight estimates that the RR on Bishop stock is 9%, but Royal believes the RR is 10%. Royal's valuation of Bishop stock is approximately:

A. equal to Knight's valuation B. $5 less than Knight's valuation C. $5 more than Knight's valuation.

Exhibit 1-3 DCom Corp. Summary Income Statement and Balance Sheet (U.S. $ millions, except per share data) December. 31 2000 2001 2002 2003 Actual Projection Projection Projection $ 70.00 $ 105.00 $ 157.50 $ 236.25 $ 30.45 $ 45.68 $ 68.51 $ 102.77 $ 39.55 $ 59.32 $ 88.99 $ 133.48 Summary Income Statement (for the year) Total Revenue Total Operating Expenses Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA) Depreciation and Amortization Earnings Before Interest & Taxes (EBIT) Interest Expense Pre-tax Income Income Tax Expense Net Income $ 69.00 $ 129.00 $ 136.50 $ 144.00 $ (29.45) $ (69.68) $ (47.51) $ (10.52) $ 44.10 $ 79.20 $ 87.75 $ 87.75 $ (73.55) $ (148.88) $ (135.26) $ (98.27) $ (22.07) $ (44.66) $ (40.58) $ (29.48) $ (51.49) $ (104.22) $ (94.68) $ (68.79) Summary Balance Sheet (year end) Total Current Assets Net Fixed Assets Total Assets 2000 2001 2002 2003 Actual Projection Projection Projection $ 113.12 $ 130.93 $ 222.07 $ 253.75 $ 391.00 $ 662.00 $ 575.50 $ 481.50 $ 504.12 $ 792.93 $ 797.57 $ 735.25 Total Current Liabilities Long-term Debt Total Liabilities Common Stock Retained Earnings Total Shareholder's Equity Total Liabilities and Equity $ 5.60 $ 8.63 $ 12.95 $ 19.42 $ 490.00 $ 880.00 $ 975.00 $ 975.00 $ 495.60 $ 888.63 $ 987.95 $ 994.42 $ 60.00 $ 60.00 $ 60.00 $ 60.00 $ (51.49) $ (155.70) $ (250.38) $ (319.17) $ 8.51 $ (95.70) $ (190.38) $ (259.17) $ 504.12 $ 792.93 $ 797.57 $ 735.25 Dividends $ $ $ $ Capital Expenditures Changes in Working Capital (excluding cash and short-term debt) $ 400.00 $ $ 5.19 $ 50.00 $ (4.32) $ 50.00 (6.47)