Question

Bayou Okra Farms just paid a dividend of $3.85 on its stock. The growth rate in dividends is expected to be a constant 4 percent per year indefinitely. Investors require a return of 12 percent for the first three years, a return of 10 percent for the next three years, and a return of 8 percent thereafter. What is the current share price?

Answer 1

Answer:

The answer is "$86.44".

Explanation:

The more recent dividends paid $= \ \ 3.85$

Level of growth $= 4 \%$  

Required returns level for a first 3 years = 12 $\%$

Required returns rate for year 3 to year 6 = 10 $\%$

Required returns level after years 6= 8 $\%$

Formula:

$\text{Value of stock}= \frac{ \text{Last Dividend} \times (1+ Growth \ rate)}{\text{(Required rate of return - Growth Rate)}}$

Divididend payment for year O to year 6 is calculated below:

Year                            $0 \ \ \ \ \ \ \ \ \ \ \ 1 \ \ \ \ \ \ \ \ \ \ \ 2 \ \ \ \ \ \ \ \ \ \ \ 3 \ \ \ \ \ \ \ \ \ \ \ 4 \ \ \ \ \ \ \ \ \ \ \ 5 \ \ \ \ \ \ \ \ \ \ \ 6$

Rate of return needed             12$\%$        12$\%$          12$\%$          10$\%$            10$\%$      10$\%$    

Collection of dividend$\ \ 3.85 \ \ \ \ \ \ 4.00 \ \ \ \ \ \ 4.16 \ \ \ \ \ \ 4.33 \ \ \ \ \ \ 4.50 \ \ \ \ \ \ 4.68 \ \ \ \ \ \ 4.87$  Benefit of terminal                                                                                  126.6584  

Dividend purchase price  3.58       3.32          3.08      3.08      2.91        2.75     Terminal value at year-end 3                         95.16

Present dividend value         67.73    

Value of Stock                $86.44