Question

1. Orwell building supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 31.00% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (r_s) is 12%. What is the best estimate of the current stock price?

2. Carby Hardware has an outstanding issue of perpetual preferred stock with an annual dividend of $9.30 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?

Answer 1

1) Calculation of stock's current price:
Year	Amount	PVF @12%	Present value
1	2.29	0.893	2.05
2	3.00	0.797	2.39
2	53.00	0.797	42.24
Total			46.68
Value of share is $46.68
Working:
Calculation of dividend:
Year 1= dividend(1+ growth)= 1.75*(1+0.31)= 2.29
Year 2= Dividnd (1+growth)= 2.29*(1+0.31)= 3.00
Terminal value= Dividend(1+growth)/(return-growth)
=3.00*(1+0.06)/(0.12-0.06)
= 3.18/0.06= 53
2) Calculation of value of preferred stock:
Value of preferred stock= dividend/ required return
Value of preferred stock= 9.3/0.065= $143.08
Value of preferred stock is $143.08