Complete The Following Questions In The Attached Excel Sprea
Complete The Following Questions In The Attached Excel Spreadsheet
Complete the following questions in the attached Excel spreadsheet. Problem one CONSTANT-GROWTH COMMON STOCK 1. What is the value of a common stock if the firm's earnings and dividends are growing annually at 10%, the current dividend is $1.32, and investors require a 15% return on investment? 2. What is the stock's rate of return if the market price of the stock is $35? Problem Two Preferred Stock Price and Return 1. A firm has preferred stock outstanding with a $1,000 par value and a $40 annual dividend with no maturity. If the required rate of return is 9%, what is the price of the preferred stock? 2. The market price of a firm's preferred stock is $24 and pays an annual dividend of $2.50. If the stock's par value is $1,000 and it has no maturity, what is the return on the preferred stock?
Paper For Above instruction
Introduction
The valuation of stocks and understanding of dividend returns are fundamental concepts in finance that help investors make informed decisions. In particular, the valuation of common stocks with growth prospects and preferred stocks with fixed dividends presents diverse challenges and opportunities for investors. This paper discusses the calculation of common stock value under the constant growth dividend discount model (DDM), and evaluates preferred stock price and return computation, demonstrating how these models are applied to real-world investment scenarios.
Valuation of Constant-Growth Common Stock
The constant growth dividend discount model, developed by Myron Gordon, provides a straightforward approach to valuing stocks that grow dividends at a steady rate. The formula for the intrinsic value of a stock in this model is:
\[
P_0 = \frac{D_1}{r - g}
\]
where:
- \(P_0\) = current stock price,
- \(D_1\) = dividend one year from now,
- \(r\) = required rate of return,
- \(g\) = growth rate of dividends.
In the problem scenario, the current dividend \(D_0\) is $1.32, with dividends expected to grow at 10% annually (\(g = 0.10\)). The next year's dividend is:
\[
D_1 = D_0 \times (1 + g) = \$1.32 \times 1.10 = \$1.452
\]
Given the required return \(r = 0.15\), the stock value is calculated as:
\[
P_0 = \frac{\$1.452}{0.15 - 0.10} = \frac{\$1.452}{0.05} = \$29.04
\]
This valuation suggests that the intrinsic value of the stock, considering growth expectations and investor required returns, is approximately $29.04.
The second question in problem one asks for the stock's rate of return if the market price is $35. Using the Gordon Growth Model rearranged to solve for \(r\):
\[
r = \frac{D_1}{P_0} + g
\]
Substituting the known values:
\[
r = \frac{\$1.452}{\$35} + 0.10 \approx 0.0415 + 0.10 = 0.1415 \text{ or } 14.15\%
\]
This indicates that if the stock's market price is $35, the implied rate of return based on dividend forecasts and growth is approximately 14.15%.
Valuation and Return on Preferred Stock
Preferred stocks are generally valued based on fixed dividends because they have no maturity date and dividends are often constant. The valuation formula for preferred stock with no maturity and fixed dividends is:
\[
P = \frac{D}{r}
\]
Where:
- \(P\) = preferred stock price,
- \(D\) = annual dividend,
- \(r\) = required rate of return.
For scenario one, with a preferred stock dividend \(D = \$40\) and required return \(r = 0.09\):
\[
P = \frac{\$40}{0.09} \approx \$444.44
\]
Thus, the intrinsic value of the preferred stock, given these parameters, is approximately $444.44.
In the second preferred stock scenario, with a market price of $24 and an annual dividend of $2.50, the yield (or return) can be calculated as:
\[
r = \frac{D}{P} = \frac{\$2.50}{\$24} \approx 0.1042 \text{ or } 10.42\%
\]
This indicates that the preferred stock yields an annual return of roughly 10.42%, which reflects the investor's expected return given current market prices and dividend payments.
Discussion
The valuation models employed are vital tools for investors and analysts. For common stocks, the Gordon Growth Model provides an elegant solution assuming a constant dividend growth rate. It is particularly useful for mature companies with stable dividend policies. However, the assumptions of constant growth and investor required returns must be carefully assessed, as deviations can significantly impact valuation accuracy.
Preferred stock valuation assumes fixed dividends, making it simpler and more predictable. However, the market price can fluctuate based on interest rate changes, investor perception, and company performance. The calculated yield shows the expected return for an investor purchasing at current market prices, and this figure can serve as a benchmark for investment decisions.
Furthermore, the concept of the required rate of return is central to valuation. It affects both the present value of future dividends and the perceived attractiveness of stocks relative to alternative investments. Understanding these models enables investors to evaluate whether stocks are over- or undervalued, aiding in strategic portfolio management.
Conclusion
Valuation techniques such as the dividend discount model for common stocks and fixed-dividend valuation for preferred stocks remain foundational in finance. Accurate calculations of stock value and expected returns provide essential information for investment decisions, risk assessment, and strategy development. As markets evolve, these models should be complemented with other analyses, including quantitative and qualitative assessments, to achieve comprehensive valuation insights.
References
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