Question

Coal Co. just announced that it will commence paying annual dividends. It plans to pay $1.75 a year for four years, $1.25 a year for the following three years, and then cease paying dividends altogether. How much is one share of this stock worth to you today if you require an 8 percent rate of return?

a) $8.16

b) $6.32

c) $5.15

d) $7.79

Answer 1

a) $8.16

Working:

As per dividend discount model, current value of stock is the present value of dividend.
Present value of dividends is calculated as follows:
Year	Dividend	Discount factor	Present Value
a	b	c=1.08^-a	d=b*c
1	$       1.75	0.9259	$       1.62
2	$       1.75	0.8573	$       1.50
3	$       1.75	0.7938	$       1.39
4	$       1.75	0.7350	$       1.29
5	$       1.25	0.6806	$       0.85
6	$       1.25	0.6302	$       0.79
7	$       1.25	0.5835	$       0.73
	Total		$       8.16
So, value of one share today is			$       8.16