Section 1 (25 marks)

a. The broker offers to sell you some shares of ABC & Co. common stock that paid annual dividend of $2.00 yesterday. ABCs dividend is expected to grow at 5% per year for the next 3 years. If you buy the stock, you plan to hold it for 3 years and then sell it. The appropriate discount rate is 12%.

i. Calculate the expected dividend for each of the next 3 years. [3 marks]

ii. Given that the first dividend payment will occur 1 year from now, find the present value of the dividends stream. [3 marks]

iii. You expect the stock price at the third year to be $34.74. Discounted at a 12% rate, what is the present value of this expected future stock price? [3 marks]

iv. If you plan to buy the stock, hold it for 3 years, and sell it for $34.73, what is the most you should pay for it today? [3 marks] v. Calculate the present value of this stock by using the constant growth model. Assume that g = 5% and that it is constant. [3 marks]

b. From the perspective of either an investor and firm, which of the financing ways is preferable? Debt or equity? Please justify your choice with relevant reasons (Not more than 200 words). [10 marks]

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