XYZ just paid a dividend of $ 2.65 on its shares. The dividend growth rate is...

XYZ just paid a dividend of $ 2.65 on its shares. The dividend growth rate is expected to be constant 4% per annum forever. Investors demand a return of 16% for the first three years, a return of 14% for the next three years and a return of 11% thereafter. What is the current price of this financial instrument?

Expert Solution

Current price is $ 32.74

As per dividend discount model, current price of financial instrument is the present value of future dividend.

Step-1:Present value of dividend of first 6 years

Present value of dividend of year:

1	=	2.65	*	1.04^1	*	1.16^-1			=	$ 2.38
2	=	2.65	*	1.04^2	*	1.16^-2			=	$ 2.13
3	=	2.65	*	1.04^3	*	1.16^-3			=	$ 1.91
4	=	2.65	*	1.04^4	*	1.16^-3	*	1.14^-1	=	$ 1.74
5	=	2.65	*	1.04^5	*	1.16^-3	*	1.14^-2	=	$ 1.59
6	=	2.65	*	1.04^6	*	1.16^-3	*	1.14^-3	=	$ 1.45

Total										$ 11.20

Step-2:Present value of dividend after year 6

Present value	=	D6(1+g)/(k-g)DF6			Where,
	=	$ 21.54			D6	2.65	*	1.04^6	=	$ 3.35
					g				=	4%
					k					11%
					DF6	1.16^-3	*	1.14^-3	=	0.432426

Step-3:Sum of present value of future dividends

Sum of present value of future dividends	=	$ 11.20	+	$ 21.54
	=	$ 32.74

jeff jeffy answered 3 months ago

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