A. Incorrect

• 50% is the result when using 9% as $r$ rather than 8%.

r = 9\%: \quad V_0 = \frac{2}{0.09 - 0.04} = \frac{2}{0.05} = \`$40`

A decrease from `40` to \`20` equals a 50% decrease.

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B. Correct

• The estimated value ($V_0$) is expressed as:

$$V_0 = \frac{D_1}{r - g}$$

Where:

• $D_1$ = next year’s expected dividend
• $r$ = required return
• $g$ = dividend growth rate

Calculations:

r = 8\%: \quad V_0 = \frac{2}{0.08 - 0.04} = \frac{2}{0.04} = \`$50` r = 14\%: \quad V_0 = \frac{2}{0.14 - 0.04} = \frac{2}{0.10} = \`$20`

When the required rate of return increases to 14%, the value estimate decreases `30` from \`50`, or 60%.

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C. Incorrect

• 75% is the increase from 8% to 14%.

$$\frac{14\%}{8\%} - 1 = 0.75 = 75\%$$

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Equity Valuation: Concepts and Basic Tools

• Calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate.