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1) Use the formula for constant growth perpetuity to compute the value of a share of common stock that will pay a 4% dividend next year, assuming the opportunity cost K is 15% and the firm is growing its dividend at a constant rate of 8% per year, (based on a return on equity of 10% and a plowback ratio of 80%). How would the valuation change if the growth rate was 0%? What is the extra value associated with growth? How would the valuation change if the opportunity cost rose or fell or if the dividend growth rate increased or decreased, all else remaining the same?

2) Automated Manufacturers uses high-tech equipment to produce specialized aluminum products for its customers. Each one of these machines costs $1,480,000 to purchase plus an additional $52,000 a year to operate. The machines have a 6-year life after which they are worthless. What is the equivalent annual cost of one of these machines if the required return is 16 percent?

Basic Finance, Finance

  • Category:- Basic Finance
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