QUESTION EIGHT

a) A Company is expected to pay a dividend in year 1 of sh1.20, a dividend in year 2 of sh1.50, and a dividend in year 3 of sh2.00. After year 3, dividends are expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth what today? (3 marks)

b) The growth in dividends of X Ltd is expected to be 8%/year for the next two years, followed by a growth rate of 4%/year for three years; after this five-year period, the growth in dividends is expected to be 3%/year, indefinitely. The required rate of return on Music Doctors, Inc. is 11%. Last year's dividends per share were sh2.75. What should the stock sell for today? (3 marks)

c) Consider two annual coupon bonds, each with two years to maturity. Bond A has a 7% coupon and a price of sh1000.62. Bond B has a 10% coupon and sells for sh1,055.12. Find the two one-period forward rates that must hold for these bonds. (6 marks)

d) Behavioral finance posits that investors possess information processing errors. Discuss the importance of information processing errors then list and explain the four information processing errors discussed in the text. (12 marks)