Question

Due to the recent success of research and development efforts of industry XYZ, it is expected to grow at a higher rate as shown below compared to the normal expected growth rate of 5% per annum as it is in the industry. However, subsequently, it is expected to follow the normal growth rate of 5% per annum as prevalent in the industry.

Year	1	2	3	4
Growth rate % pa	8	9	10	7

Given the stockholders require the rate of return of 14% per annum, and the most recent annual dividend paid out by the industry XYZ as $1.20 per share, Mr Yee , the financial controller for the industry XYZ requires your help to find the following:

a. The company's share price today

b. The total return expected during the current year, clearly indicating the dividend and the capital yield for industry XYZ.

Answer 1

As per gorden's model of current price of the stock should be equal to the present value of all the future cash inflows from the stock,

where P0 is current price of the stock, D1 is dividend expected from the stock, Ke is Cost of capital/required rate of retrun of investor, g is growth rate of earnings of the comapny. now in the above question we would first calculate the expected dividend after 5th year since the growth is uneven till 5th year. after that we would calculate price of stock at the end of 4th year that is P4 (if you stand at the end of 4the years your current price that would be P0 for you at that time. futher D1 would be the future dividend in 5th year. growth would be 5% anf Ke is 14%. from this we would get Price at year 4th as $19.40.
value of the stock price today would be $15.74, which is the present value of all the dividends expected from the stock during 4 years and price of the compay's stock at the end of year 4th when the growth rate would become constant forever. here we would not include the dividend of $1.20, since it is already paid by company. cash flow for 4 th year would be: =1.66+19.40. Part b: since growth rate in year 1 is higher which leads to higher Ke. please provide feed back in the comment section to refine the answer, i also politely request those who gave thumb-down rating to please share the reason for the same, so i can improve in future. thanks.