QuestionScotto Manufacturing's stock pays a \$2.40 dividend. Find its value at 12% and 20% required returns. Discuss risk's impact.

Studdy Solution

STEP 1

Assumptions1. The most recent common stock dividend is $.40 per share. The dividends will remain at the current level for the foreseeable future3. The required return is12% for part a and20% for part b4. The value of the stock is calculated using the formula for a perpetuity, as the dividends are expected to remain constant

STEP 2

We will use the formula for the present value of a perpetuity to calculate the value of the common stock. The formula is $Value = \frac{Dividend}{Required\, return}$

STEP 3

For part a, plug in the given values for the dividend and the required return to calculate the value of the common stock.
$Value = \frac{\$2.40}{12\%}$

STEP 4

Convert the percentage to a decimal value.
$12\% =0.12$ $Value = \frac{\$2.40}{0.12}$

STEP 5

Calculate the value of the common stock.
$Value = \frac{\$2.40}{0.12} = \$20$ The value of Scotto's common stock, if the required return is12%, is $20.

STEP 6

For part b, if the firm's risk increases and the required return rises to20%, we use the same formula but with the new required return.
$Value = \frac{\$2.40}{20\%}$

STEP 7

Convert the percentage to a decimal value.
$20\% =0.20$ $Value = \frac{\$2.40}{0.20}$

STEP 8

Calculate the new value of the common stock.
$Value = \frac{\$2.40}{0.20} = \$12$ The value of Scotto's common stock, if the required return is20%, is $12.

STEP 9

For part c, we observe that as the required return (which is a measure of risk) increases, the value of the common stock decreases. This is because as the risk increases, investors require a higher return for holding the stock, which decreases its present value. This is a general principle in finance - higher risk leads to lower value, all else being equal.

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QuestionScotto Manufacturing's stock pays a \$2.40 dividend. Find its value at 12% and 20% required returns. Discuss risk's impact.

Studdy Solution

STEP 1

STEP 2

We will use the formula for the present value of a perpetuity to calculate the value of the common stock. The formula is $Value = \frac{Dividend}{Required\, return}$

STEP 3

For part a, plug in the given values for the dividend and the required return to calculate the value of the common stock.
$Value = \frac{\$2.40}{12\%}$

STEP 4

Convert the percentage to a decimal value.
$12\% =0.12$ $Value = \frac{\$2.40}{0.12}$

STEP 5

Calculate the value of the common stock.
$Value = \frac{\$2.40}{0.12} = \$20$ The value of Scotto's common stock, if the required return is12%, is $20.

STEP 6

For part b, if the firm's risk increases and the required return rises to20%, we use the same formula but with the new required return.
$Value = \frac{\$2.40}{20\%}$

STEP 7

Convert the percentage to a decimal value.
$20\% =0.20$ $Value = \frac{\$2.40}{0.20}$

STEP 8

Calculate the new value of the common stock.
$Value = \frac{\$2.40}{0.20} = \$12$ The value of Scotto's common stock, if the required return is20%, is $12.

STEP 9

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QuestionScotto Manufacturing's stock pays a \$2.40 dividend. Find its value at 12% and 20% required returns. Discuss risk's impact.

Studdy Solution

STEP 1

STEP 2

We will use the formula for the present value of a perpetuity to calculate the value of the common stock. The formula isValue=DividendRequired returnValue = \frac{Dividend}{Required\, return}Value=RequiredreturnDividend​

STEP 3

For part a, plug in the given values for the dividend and the required return to calculate the value of the common stock.Value=$2.4012%Value = \frac{\$2.40}{12\%}Value=12%$2.40​

STEP 4

Convert the percentage to a decimal value.12%=0.1212\% =0.1212%=0.12Value=$2.400.12Value = \frac{\$2.40}{0.12}Value=0.12$2.40​

STEP 5

Calculate the value of the common stock.Value=$2.400.12=$20Value = \frac{\$2.40}{0.12} = \$20Value=0.12$2.40​=$20The value of Scotto's common stock, if the required return is12%, is $20.

STEP 6

For part b, if the firm's risk increases and the required return rises to20%, we use the same formula but with the new required return.Value=$2.4020%Value = \frac{\$2.40}{20\%}Value=20%$2.40​

STEP 7

Convert the percentage to a decimal value.20%=0.2020\% =0.2020%=0.20Value=$2.400.20Value = \frac{\$2.40}{0.20}Value=0.20$2.40​

STEP 8

Calculate the new value of the common stock.Value=$2.400.20=$12Value = \frac{\$2.40}{0.20} = \$12Value=0.20$2.40​=$12The value of Scotto's common stock, if the required return is20%, is $12.

STEP 9

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We will use the formula for the present value of a perpetuity to calculate the value of the common stock. The formula is $Value = \frac{Dividend}{Required\, return}$

For part a, plug in the given values for the dividend and the required return to calculate the value of the common stock.
$Value = \frac{\$2.40}{12\%}$

Convert the percentage to a decimal value.
$12\% =0.12$ $Value = \frac{\$2.40}{0.12}$

Calculate the value of the common stock.
$Value = \frac{\$2.40}{0.12} = \$20$ The value of Scotto's common stock, if the required return is12%, is $20.

For part b, if the firm's risk increases and the required return rises to20%, we use the same formula but with the new required return.
$Value = \frac{\$2.40}{20\%}$

Convert the percentage to a decimal value.
$20\% =0.20$ $Value = \frac{\$2.40}{0.20}$

Calculate the new value of the common stock.
$Value = \frac{\$2.40}{0.20} = \$12$ The value of Scotto's common stock, if the required return is20%, is $12.