Paul Dargis Analyzed Five Stocks

1. Paul Dargis has analyzed five stocks and estimated the dividends they will pay next year as well as their prices at the end of the year. His projections are shown below.

Current Projected Projected

Stock Price Dividend Stock Price

A $37.50 $1.45 $43.00

B $24.50 $0.90 $26.50

C $57.80 $2.10 $63.50

D $74.35 None $81.00

E $64.80 $3.15 $63.00

Compute the dividend yield, capital gains yield, and total one-year return implied by Paul's estimates for each stock.

SOLUTION:

Stock A

Dividend Yield: $1.45/$37.50 = 3.87%

Capital Gains Yield: ($43.00 - $37.50)/$37.50 = 14.67%

Total Yield: 3.87% + 14.67% = 18.54%

Stock B

Dividend Yield: $.90/$24.50 = 3.67%

Capital Gains Yield: ($26.50 - $24.50)/$24.50 = 8.16%

Total Yield: 3.67% + 8.16% = 11.83%

Stock C

Dividend Yield: $2.10/$57.80 = 3.63%

Capital Gains Yield: ($63.50 - $57.80)/$57.80 = 9.86%

Total Yield: 3.63% + 9.86% = 13.49%

Stock D

Dividend Yield: $0/$74.35 = 0.0%

Capital Gains Yield: ($81.00 - $74.35)/$74.35 = 8.94%

Total Yield: 8.94%

Stock E

Dividend Yield: $3.15/$64.80 = 4.86%

Capital Gains Yield: ($63.00 - 64.80)/$64.80 = (2.78%)

Total Yield: 4.86% + (2.78%) = 2.08%

4. Mitech Corp's stock has been growing at approximately 8% for several years and is now $30. Based on past growth rate performance, what would you expect the stock's price to be in five years?

SOLUTION:

Pn+1 = Pn (1+g)

P5 = P0 (1.08)5 = P0(1.08) (1.08) (1.08) (1.08) (1.08) = $30.00(1.4693) = $44.08

5. The Spinnaker Company has paid an annual dividend of $2 per share for some time. Recently the board of directors voted to grow the dividend by 6% from now on. What is the most you would be willing to pay for a share of Spinnaker if you expect a 10% return on your stock investments?

SOLUTION:

Apply the Gordon Model

P0 = D0(1 + g) / (k - g)

= $2(1.06) / (.10 − .06)

= $2.12 / .04

= $53.00

6. The Pancake Corporation recently paid a $3 dividend, and is expected to grow at 5% forever. Investors generally require an expected return of at least 9% before they'll buy stocks similar to Pancake.

a. What is Pancake's intrinsic value?

b. Is it a bargain if it's selling at $76 a share?

SOLUTION:

a. EMBED Equation.3

b. That's not apparent. Although our calculated intrinsic price exceeds the market price, it only does so by about 4%. The modeling technique isn't accurate enough to identify 4% differences. Our result says that the stock has probably been priced about right by the market.

8. The Anderson Pipe Co. just paid an annual dividend of $3.75 and is expected to grow at 8% for the foreseeable future. Harley Bevins generally demands a return of 9% when he invests in companies similar to Anderson.

a. What is the most Harley should be willing to pay for a share of Anderson?

b. Is your answer reasonable? What's going here? What should Harley do with this result?

SOLUTION:

a. Apply the Gordon Model

P0 = D0(1 + g) / (k - g)

= $3.75(1.08) / (.09 − .08)