Question

projects to pay a dividend of $.75 next year and then have it grow at 12% for the following 3 years before growing at 8% indefinitely thereafter. The equity has a required return of 10% in the market. The price of the stock should be _

Answer 1

Answer:

Price of stock = 41.67

Explanation:

The dividend valuation model states the price of a stock is the present value of the expected future dividends discounted at the required rate of return.

Year                                                         Present Value

1      0.75 × 1.1^(-1)   =                              0.6818

2     0.75 × 1.12  × 1.1^(-2)   =                  0.6942

3     0.75 × 1.12^2 × 1.1^(-3)   =              0.7068

4       0.75  × 1.12^3 × 1.1^(-4)  =             0.71968

5 to infin.  (See workings below)          38.8631

Price of the stock                                   41.6657

Price of stock = 41.67

Workings:

Present value of year 5 to infinity

Year 5 will be don in two steps

PV (in year 4) =  (0.75  × 1.12^3 ×1.08 )/(0.1-0.08)

PV (in year 4)    =56.899584

PV in year 0

(56.899584 × 1.1^(-4) =38.86318148