Question

Combined Communications is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 23 percent a year for the next 4 years and then decreasing the growth rate to 5 percent per year. The company just paid its annual dividend in the amount of $1.10 per share. What is the current value of one share of this stock if the required rate of return is 9.00 percent? $44.37 $52.83 $40.76 $47.34 $52.50

Answer 1

Step 1: Computation of market price at the end of year 4 using Gordon Growth Model

P4 = D5 / (Ke – g)

Where,

P4 - Market price at the end of year 4 =?

D5 - Expected dividend in year 5 = 1.10*1.23^4*1.05 = 2.64364070355

Ke – Cost of equity = 9%

G – Growth rate in dividend = 5%

P4 = 2.64364070355/(.09-.05)

= 2.64364070355/.04

= $66.09

Step 2: Computing current share price by discounting the cashflow at required return

Year	Dividend	PVF@9%	Present Value (Cashflow*PVF)
1	1.35(1.1*1.23)	0.917	1.24
2	1.66(1.1*1.23^2)	0.842	1.40
3	2.05(1.1*1.23^3)	0.772	1.58
4	68.61(1.1*1.23^4+66.09)	0.708	48.61

current share price = Cashflow*PVF

= 1.24+1.40+1.58+48.61

= $52.83

You can use the equation 1/(1+i)^n to find PVF using calculator