Question

(ONLY NEED STOCK C ANSWERS)

Consider the following three stocks:

Stock A is expected to provide a dividend of $10.40 a share forever.

Stock B is expected to pay a dividend of $5.40 next year. Thereafter, dividend growth is expected to be 2.00% a year forever.

Stock C is expected to pay a dividend of $5.40 next year. Thereafter, dividend growth is expected to be 18.00% a year for five years (i.e., years 2 through 6) and zero thereafter.

a-1. If the market capitalization rate for each stock is 8.00%, what is the stock price for each of the stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

b-1. If the market capitalization rate for each stock is 5.00%, what is the stock price for each of the stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Answer 1

Year 1 dividend = 5.4

Year 2 dividend = 5.4 * 1.18 = 6.372

Year 3 dividend = 6.372 * 1.18 = 7.51896

Year 4 dividend = 7.51896 * 1.18 = 8.872373

Year 5 dividend = 8.872373 * 1.18 = 10.4694

Year 6 dividend = 10.4694 * 1.18 = 12.353892

Year 7 dividend = 12.353892

a-1)

Value at year 6 = perpetual cash flow / rate

Value at year 6 = 12.353892 / 0.08

Value at year 6 = 154.423649

Value of stock at 8% = 5.4 / (1 + 0.08)¹ + 6.372 / (1 + 0.08)² + 7.51896 / (1 + 0.08)³ + 8.872373 / (1 + 0.08)⁴ + 10.4694 / (1 + 0.08)⁵ + 12.353892 / (1 + 0.08)⁶ + 154.423649 / (1 + 0.08)⁶

Value of stock at 8% = $135.18

b-1)

Value at year 6 = perpetual cash flow / rate

Value at year 6 = 12.353892 / 0.05

Value at year 6 = 247.07784

Value of stock at 5% = 5.4 / (1 + 0.05)¹ + 6.372 / (1 + 0.05)² + 7.51896 / (1 + 0.05)³ + 8.872373 / (1 + 0.05)⁴ + 10.4694 / (1 + 0.05)⁵ + 12.353892 / (1 + 0.05)⁶ + 247.07784 / (1 + 0.05)⁶

Value of stock at 5% = $226.51