1.

In practice, a common way to value a share of stock when a company pays dividends is to value the dividends over the next five years or so, then find the "terminal" stock price using a benchmark PE ratio. Suppose a company just paid a dividend of $1.85. The dividends are expected to grow at 10 percent over the next five years. In five years, the estimated payout ratio is 45 percent and the benchmark PE ratio is 35.

What is the stock price today assuming a required return of 12.5 percent on this stock?

What is the target stock price in five years?

2.

Suppose we have the following returns for large-company stocks and Treasury bills over a six year period:

Year	Large Company	US Treasury Bill
1	3.66	4.66
2	14.44	2.33
3	19.03	4.12
4	-14.65	5.88
5	-32.14	4.90
6	37.27	6.33

a.	Calculate the arithmetic average returns for large-company stocks and T-bills over this period.(Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

	Average returns
Large company stocks	%
T-bills	%

b.	Calculate the standard deviation of the returns for large-company stocks and T-bills over this period.(Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

	Standard deviation
Large company stocks	%
T-bills	%

c-1

Calculate the observed risk premium in each year for the large-company stocks versus the T-bills. What was the average risk premium over this period?(Negative amount should be indicated by a minus sign.Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Average risk premium

%

c-2	Calculate the observed risk premium in each year for the large-company stocks versus the T-bills. What was the standard deviation of the risk premium over this period?(Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Standard deviation

%

3.

Suppose the returns on an asset are normally distributed. The historical average annual return for the asset was 7.6 percent and the standard deviation was 8.6 percent. What is the probability that your return on this asset will be less than -9.3 percent in a given year? Use the NORMDIST function in Excel to answer this question.(Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Probability

%

4.

Suppose we have the following Treasury bill returns and inflation rates over an eight year period:

Year	Treasury Bills	Inflation
1	10.45%	12.55%
2	11.36	16.00
3	9.06	10.29
4	8.34	7.97
5	8.88	10.29
6	11.23	12.77
7	14.11	16.98
8	15.97	16.90

a.	Calculate the average return for Treasury bills and the average annual inflation rate for this period.(Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Treasury bills	%
Inflation	%

b.	Calculate the standard deviation of Treasury bill returns and inflation over this period.(Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Treasury bills	%
Inflation	%

c.	What was the average real return for Treasury bills over this period?(Negative amount should be indicated by a minus sign.Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Average real return

%