Kenneth R. Szulczyk

     

150.22

1 0.1

168.67

1 0.1

6.3648

1 0.1

6.12

0 2 2 =$

+

$

+

+

$

+

+

$

P= ( 25 )

A new startup internet company does not pay dividends for the first three years. In year 4,
the company begins paying a dividend of $10 per share that grows 5% per year. If the rate of
return is 8%, then calculate the market value of the stock.

 First, we set the dividends to zero for the initial three years, which means D 1 = D 2 = D 3 = 0

 Second, we set the dividend to $10, for the fourth time period, or D 4 = $10. Next, we

calculate the perpetuity that begins in Period 3 in Equation 26.

333.33

0.08 0.05

4 10

3 =$

$

=

r g

D

P=

 

( 26 )

Unfortunately, Equation 26 yields the market value of stock for Period 3. If we are in Year
0 for the cash flow, then we use the present value formula to calculate the stock price in Time 0
in Equation 27. Consequently, the market value of the stock equals $264.61 per share.

 

264.61

1 0.08

333.33

0 3 =$

+

$

P= ( 27 )

Key Terms

bond
notes payable
stock
discount bond
coupon bond
premium
discount
consul
perpetuity

registered bond

bearer bond

debenture bond

convertible bond

municipal bond

discount rate

yield to maturity

capital gain

capital loss

Chapter Questions

1. Explain the similarities and differences between notes payable and a corporate bond.


2. Identify the advantages of issuing more bonds instead of stock.