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C15.0002
Foundations of Finance
Summer 2002
Section 001: TR 12:00-2:55 PM, TISCH LC10
HOMEWORK # 3 -----To be handed in 7/30/02
QUESTIONS:
1. Ameritech Corporation paid dividends per share of $3.56 in 1992, and dividends are expected to grow 5.5% a year forever. The stock has a beta of 0.90, and the treasury bond rate is 6.25%.
a) What is the value per share, using the Gordon Growth Model?
b) The stock is trading for $80 per share. What would the growth rate in dividends have to be to justify this price?
2. The consensus forecast of security analysts of your favorite company is that earnings next year will be $5.00 per share. The company plows back 50% of its earnings and the Chief Financial Officer (CFO) estimates that the company’s ROE is 16%.

a) If your estimate of the company’s required rate of return on its stock is 10%, what should be the price of the stock?

b) Suppose you observe that the stock is selling for $50.00 per share, and that this is the best estimate of its equilibrium price, what would you conclude about either your estimate of the stock’s required rate of return or the CFO’s estimate of the company’s return on equity?

c) Suppose you believe your own 10 percent estimate of the stock’s required rate of return, what does the market price of $50.00 per share imply about the market’s estimate of the company’s expected return on equity?

3. Assume that the constant growth dividend growth model can be used for valuation. The SSB Corporation’s shares are expected to grow indefinitely by 6% per year.

a) If the dividend to be paid one year from now is expected to be $5 and the market capitalization rate is 14% per year, what must the current stock price be?

b) If expected earnings per share for the coming year are $8, what is the implied return on equity?

c) How much is the market paying for growth

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