Question
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,
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.
| 2002 | 2003 | 2004 | Terminal Value | |
| Projected Divided = Dn | $0.74 | $0.74 | $1.85 | $2.00 |
| Divided Growth Rate = g | 8% | |||
| Required Rate of Retrun = r | 11% | 11% | 11% | 11% |
| TerminalValue=(D2004 x (1+g)) / (r2004 - g) | $66.67 | <--- | ||
| Present Value of Dividends @ 11% | $0.67 | $0.60 | $1.35 | |
| Present Value of Terminal Value @ 11% | $48.75 | |||
| Share Price Based on DDM | $51.37 |
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started