1. Examples
Example A: …
Question: Suppose Blue Skies stock is selling for $75 a share (P0 = $75). Investors expect a $3 cash dividend over the next year (DIV1 = $3). They also expect the stock to sell for $81 a year hence (P1 = $81). Then the expected return to stockholders is …

2. 12 percent Examples Answer: Example A: …
Question: Suppose Blue Skies stock is selling for $75 a share (P0 = $75). Investors expect a $3 cash dividend over the next year (DIV1 = $3). They also expect the stock to sell for $81 a year hence (P1 = $81).

3. Examples Answer: Example B: …
Question: Assume a dividend has just been paid. The next dividend, to be paid in a year, is forecast at DIV1 = $3, the growth rate of dividends is g = 8% , and the discount rate is r = 12%. The stock value is…

4. $ 75 Examples Answer: Example B: …
$ 75
Question: Assume a dividend has just been paid. The next dividend, to be paid in a year, is forecast at DIV1 = $3, the growth rate of dividends is g = 8% , and the discount rate is r = 12%. The stock value is…

5. Examples
Example C: …
Question: Better Mousetraps has come out with an improved product, and the world is beating a path to its door. As a result, the firm projects growth of 20 percent per year for 4 years. By then, other firms will have copycat technology, competition will drive down profit margins, and the sustainable growth rate will fall to 5 percent. The most recent annual dividend was DIV0 = $1.00 per share.
a. What are the expected values of DIV1, DIV2, DIV3, and DIV4?; b. What is the expected stock price 4 years from now? The discount rate is 10 percent; c. What is the stock price today?; d. Find the dividend yield, DIV1/P0.; e. What will next year’s stock price, P1, be?; f. What is the expected rate of return to an investor who buys the stock now and sells it in 1 year? 1

6. Examples Example D: … Question:
Gentleman Gym just paid its annual dividend of $2 per share, and it is widely expected that the dividend will increase by 5 percent per year indefinitely.
a. What price should the stock sell at? The discount rate is 15 percent.
b. How would your answer change if the discount rate were only 12 percent? Why does the answer change?