CHAPTER 14
Quick Check
1 a. True
b. True
2. a. Real. Nominal profits are likely to move with inflation; real profits are easier to forecast.
3. a. exact 2.498% approximate 2.5%
4. a. The equation discounts the first dividend received so it must be received one period in the future.
5. a. $V=$100/0.1=$1000
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c. i = 2%: PV of consol=$5000; 10 years: $816.22; 20 years: $1567.85; 30 years: $2184.44; 60
6. a. Very little will happen to stock prices. Only the term in from of the first dividend gets slightly
b. Now all the discount factors get slightly smaller and the terms in front of all expected dividends
Dig Deeper
7. a. The discount rate is the interest rate. So, in case (i), the EPDV is $2,000(1-0.25) under either
b. The interest rate does not enter the calculation. Hence, you prefer (ii) to (i) since 20%<25%.
8. a. Houses last a long time. Rents are likely to rise with inflation. Real interest rates would be better.
b. Let
Rt+n
e
be the expected real rent on the house. Let
QHt
❑
be the price of a house. We can
let xH be the risk premium on a house. The equation would be
QHt =Rt+1
e
(1+r1t+xh)
+
H
1+r1t+2
e+x¿
¿
(
1+r1t+xH
)
¿
Rt+2
e
¿
+ …….
c. The future rents would be discounted less and the price would rise.
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Explore Further
9. a.This measure did predict the US crash – see the Box “The Increase in US Housing Prices:
b. The ratio of the house price to income is a sort of measure of the ability to pay the rents on houses
10. Answers will vary depending on when the website is accessed.
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