2976 Words12 Pages

Questions 1. According to ValueLine estimates in Figure 1, James River’s expected an¬nu¬al dividend growth rate from the 91–93 to 97–99 period is 5.50%, and the next dividend (1995) is expected to be $0.60. Assume that the re¬quired return for James River was 8.36% on January 1 1995 and that the 5.50% growth rate was expected to continue indefinitely. a. Based on the Constant Growth Rate or Gordon Model, what was James River’s price at the beginning of 1995?
$20.98 (See Excel) b. What conditions must hold to use the constant growth model? Do many “real world” stocks satisfy the constant growth assumptions?
The constant growth model requires the dividends per share to grow at the constant rate indefinitely. This also states that the company always has to increase its earnings by the same constant rate every year so that the dividends payout will be at a constant growth.
By the looking at what is required to satisfy the constant growth model, it is fair to say that many “real world” stocks cannot satisfy the constant growth assumption. The constant growth assumption can be met by large and companies who have been around for a long time. Because the assumption does not require for the growth to be at the same constant every year, instead it states that the best estimate of growth for any future year is the expected growth rate from the previous year. It is just very unreasonable to assume that the growth rate will be constant every year. Companies just cannot maintain the same rate earning every year; sure they can for a few years in a row but not forever. If they do there could be a suspicion of fraud. 2. The Wall Street Journal (WSJ) lists the current price of James River com¬mon stock at $27.00. a. Based on this information, the ValueLine 1995 expected dividend, and the annual rate of dividend change for the growth estimate, what is the company’s

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