Question

Orca, Inc. announced today that it will begin paying annual dividends. The first dividend will be paid next year in the amount of $1.5 a share. The following dividends will be $1.31, $1.58, and $2.17 a share annually for the following three years, respectively. After that, dividends are projected to increase by 3.8 percent per year. How much are you willing to pay today to buy one share of this stock if your required rate of return is 10.5 percent?

Answer 1

Dividend of year 1 (D1) = $1.50

Dividend of year 2 (D2) = $1.31

Dividend of year 3 (D3) = $1.58

Dividend of year 4 (D4) = $2.17

Dividend Growth rate after year 4 (g) = 3.8%p.a.

Required rate of return on stock (Ke) = 10.5%p.a.

Using Gordon's Dividend Growth model,

Terminal value of stock at the end of year 4 (P4) = D5/(Ke-g)

Therefore, Terminal value of stock at the end of year 4 (P4) = D4 x(1+g) / (Ke-g)

Therefore, Terminal value of stock at the end of year 4 (P4) = 2.17 x (1 + 3.8%) / (10.5% - 3.8%)

Therefore, Terminal value of stock at the end of year 4 (P4) = $33.62

Year	Dividend	Value of stock	CF from stock	PV Factor @ 10.5%	PV of stock
1	1.50		1.50	0.905	1.36
2	1.31		1.31	0.819	1.07
3	1.58		1.58	0.741	1.17
4	2.17	33.62	35.79	0.671	24.01
			PV of stock	27.61

Price I will be willing to pay = $ 27.61