Question

In: Finance

1) Home Supply Inc. has paid a constant annual dividend of $2.40 a share for the...

1) Home Supply Inc. has paid a constant annual dividend of $2.40 a share for the past 10 years. The firm just announced that dividends will increase by 15% and will stay at that amount through Year 3, after which time the dividends will increase by 6% per year indefinitely. The required return on this stock is 12 percent.

What is the stock price of Home Supply Inc.?

Expert Solution

Step-1, Dividend per share for the next 3 years

Dividend in Year 1 (D1) = $2.76 per share [$2.40 x 115%]

Dividend in Year 2 (D2) = $2.76 per share [$2.40 x 115%]

Dividend in Year 3 (D3) = $2.76 per share [$2.40 x 115%]

Step-2, Calculation of Stock Price for the Year 3 (P3)

Stock Price for the Year 3 = D3(1 + g) / (Ke – g)

= $2.76(1 + 0.06) / (0.12 – 0.06)

= $2.9256 / 0.06

= $48.76 per share

Step-3, Stock price of Home Supply Inc.

Using the Dividend Discount Model, the Stock price of Home Supply Inc is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 3

Year	Cash flow ($)	Present Value factor at 12.00%	Present Value of cash flows ($)

1	2.76	0.89286	2.46
2	2.76	0.79719	2.20
3	2.76	0.71178	1.96
3	48.76	0.71178	34.72

TOTAL			41.34

“Hence, the Stock price of Home Supply Inc. will be $41.34”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.

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