This Week 7 Assignment: Submit Your Written Answer

For This Week 7 Assignment You Will Submit Your Written Answers To Qu

For this Week 7 Assignment, you will submit your written answers to questions and calculated answers to problems on an Excel spreadsheet using formulas for your calculations. I will be downloading the spreadsheet to review the formulas in the cells of your answers. Chapter 9 Question 9-3 Question 9-4 Question 9-5 Problem 9-1 Problem 9-11 Questions. 9-3 If you bought a share of common stock, you would probably expect to receive dividends plus an eventual capital gain. Would the distribution between the dividend yield and the capital gains yield be influenced by the firm’s decision to pay more dividends rather than to retain and reinvest more of its earnings? Explain. 9-4 Two investors are evaluating GE’s stock for possible purchase. They agree on the expected value of D1 and on the expected future dividend growth rate. Further, they agree on the riskiness of the stock. However, one investor normally holds stocks for 2 years, while the other holds stocks for 10 years. On the basis of the type of analysis done in this chapter, should they both be willing to pay the same price for GE’s stock? Explain. 9-5 A bond that pays interest forever and has no maturity is a perpetual bond. In what respect is a perpetual bond similar to a no-growth common stock? Are there preferred stocks that are evaluated similarly to perpetual bonds and other preferred issues that are more like bonds with finite lives? Explain. PROBLEMS 9-1 DPS CALCULATION Weston Corporation just paid a dividend of $1.00 a share (i.e., D0 =$1 00). The dividend is expected to grow 12% a year for the next 3 years and then at 5% a year thereafter. What is the expected dividend per share for each of the next 5 years? 9-11 VALUATION OF A CONSTANT GROWTH STOCK A stock is expected to pay a dividend of $2.75 at the end of the year (i.e., D1 =2.75), and it should continue to grow at a constant rate of 5% a year. If its required return is 15%, what is the stock’s expected price 4 years from today?

Paper For Above instruction

The questions and problems presented in this assignment predominantly focus on fundamental concepts of financial valuation, dividend policy, and investment decision-making as outlined in Chapter 9 of the finance curriculum. The core themes include the implications of dividend reinvestment versus payouts, valuation methods for stocks with different holding periods, and the characteristics and valuation of perpetual bonds and preferred stock. These topics are integral to understanding how financial assets are evaluated and how investor preferences influence valuation.

Question 9-3: Impact of Dividend Policy on Yield Distribution

The distribution between dividend yield and capital gains yield is inherently influenced by a firm's dividend policy. If a company opts to pay more dividends, its current dividend yield increases, reflecting a larger portion of investor return derived from cash returns rather than capital appreciation. Conversely, retaining earnings for reinvestment often implies that the firm prioritizes growth, which may lead to higher capital gains over time. For example, a high-dividend payout might attract income-focused investors seeking immediate returns, whereas a firm that reinvests earnings aims to generate future growth, translating into capital gains for shareholders. According to the Gordon Growth Model (Gordon, 1959), the total expected return is partitioned into dividend yield and growth components; thus, an increase in dividend payments directly affects this partitioning. Therefore, a firm's decision to pay more dividends can shift the balance towards a higher dividend yield, while a focus on retention and reinvestment favors capital gains, underscoring the importance of dividend policy on return composition.

Question 9-4: Will Different Investment Horizons Affect Valuation?

Despite both investors agreeing on the expected dividend (D1) and growth rate, their different holding periods—2 years versus 10 years—can influence their valuation perspectives. The valuation approach primarily used here is the discounted dividend model (DDM), which values a stock based on expected future dividends and growth. The shorter-term investor (2 years) might focus more on the near-term dividend projections and less on long-term growth, perhaps valuing the stock based on immediate dividend expectations or adjusted discounts for risk and timing. The longer-term investor (10 years), however, places greater weight on sustained dividend growth and the long-term earnings prospects of the company (Gordon, 1959). Although both might arrive at similar intrinsic valuations based on present assumptions, their differing investment horizons mean they might discount future dividends differently or assign different weights to the assumptions, leading to potential differences in perceived fair value. Fundamentally, the difference in investment horizon influences the relevance of long-term assumptions in valuation, but if they use the same model input, their valuation might converge, especially if the dividend growth rate and risk are constant and well-understood.

Question 9-5: Perpetual Bonds and Stock Valuations

A perpetual bond, which pays interest indefinitely with no maturity date, is akin to a zero-growth preferred stock because both generate a continuous stream of payments without a specified end. The key similarity lies in their valuation: both are valued as the present value of perpetuity payments (Brealey, Myers, & Allen, 2017). A no-growth preferred stock pays a fixed dividend perpetually, matching the cash flow pattern of a perpetual bond; its value equals the fixed dividend divided by the required rate of return. Other preferred stocks evaluated similarly are those issued as perpetual instruments. Conversely, some preferred stocks are callable or have features like maturity or step-up clauses, making them more akin to bonds with finite lives, especially if the payment structure is adjusted or if they are issued with maturity dates. The valuation method for perpetuities—dividing the constant payment by the required rate—applies uniformly to these instruments, though the actual risk profile can vary significantly depending on features like callability or creditworthiness (Bodie, Kane, & Marcus, 2014).

Problem 9-1: Dividend Per Share Calculation

Given Weston Corporation's recent dividend D0 = $1.00, with expected growth rates of 12% for the next three years followed by 5%, the dividends for each of the next five years are as follows:

• Year 1: D1 = D0 × (1 + 12%) = $1.00 × 1.12 = $1.12
• Year 2: D2 = D1 × 1.12 = $1.12 × 1.12 ≈ $1.2544
• Year 3: D3 = D2 × 1.12 ≈ $1.2544 × 1.12 ≈ $1.404
• Year 4: D4 = D3 × 1.05 ≈ $1.404 × 1.05 ≈ $1.4742
• Year 5: D5 = D4 × 1.05 ≈ $1.4742 × 1.05 ≈ $1.5489

These calculations demonstrate how growth rate assumptions significantly impact future dividend estimates, crucial for valuation purposes.

Problem 9-11: Stock Valuation with Constant Growth

The stock's dividend at the end of year 1 (D1) is $2.75, with a growth rate of 5%, and a required return of 15%. The valuation four years in the future uses the Gordon Growth Model extended forward:

The formula for the price at year n is: Pn = D(n+1) / (r - g), where D(n+1) is the dividend expected at year n+1.

Dividends in future years are projected as:

• D5 = D1 × (1 + g)⁴ = $2.75 × (1.05)^4 ≈ $2.75 × 1.2155 ≈ $3.345

Therefore, the expected price 4 years from now is:

P4 = D5 / (r - g) = $3.345 / (0.15 - 0.05) = $3.345 / 0.10 = $33.45

This valuation reflects the anticipated dividends and the persistent growth rate, discounted at the required return, which encapsulates the core principles of stock valuation models.

References

• Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments (10th ed.). McGraw-Hill Education.
• Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of Corporate Finance (12th ed.). McGraw-Hill Education.
• Gordon, M. J. (1959). Dividends, earnings, and stock prices. The Review of Economics and Statistics, 41(2), 99-105.
• Higgins, R. C. (2012). Analysis for Financial Management (10th ed.). McGraw-Hill Education.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
• Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of Corporate Finance (12th ed.). McGraw-Hill Education.
• Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley Finance.
• Fabozzi, F. J. (2021). Bond Markets, Analysis, and Strategies (11th ed.). Pearson.
• Gitman, L. J., & Zutter, C. J. (2015). Principles of Managerial Finance (14th ed.). Pearson.
• Multiple authoritative sources on stock valuation, dividend policy, and fixed income valuation, emphasizing the practical application of models like Gordon’s Model and perpetuity valuation principles.