Stock valuation

7-1 Over the past 10 years, the dividends of Party Time Inc. have grown at an annual rate of 15 percent. The current (D0) dividend is $2.5per share. This dividend is expected to grow to $3.0next year, then grow at an annual rate of 10 percent for the following two years and 6 percent per year thereafter. You require a 15 percent rate of return on this stock.

a. What would you be willing to pay for a share of Party Time stock today?

b. What price would you anticipate the stock selling for at the beginning of year 3?

c. If you anticipated selling the stock at the end of two years, how much would youpay for it today?

7-2

Excel Corporation has recently witnessed a period of depressed earnings performance. As a result, cash dividend payments have been suspended.

i.Investors do notanticipate a resumption of dividends until two years from today, when a yearly dividend of $0.50will be paid.

ii.That yearly dividend is expected to be increased to $1.00in the following year and $1.50 in the year after that.

iii.Beyond the time when the$1.50 dividend is paid, investors expect Excel's dividends to grow at an annual rateof 5 percent into perpetuity. iv.All dividends are assumed to be paid at the end of eachyear. If you require an 18 percent rate of return on Excel's stock, what is the value ofone share of this stock to you today?

7.3 The VSE Corporation currently pays no dividend because of depressed earnings.

A recent change in management promises a brighter future. Investors expect VSE topay a dividend of $1 next year (the end of year 1).

This dividend is expected to increase to $2.25the following year and to grow at a rate of 10 percent per annum for thefollowing two years (years 3 and 4).

Chuck Brown, a new investor, expects the price ofthe stock to increase 75percent in value between now (time zero) and the end ofyear 3.

If Brown plans to hold the stock for threeyears and requires a rate of return of25percent on his investment, what value would he place on the stock today