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XYZ has the following dividend forecast for the next three years: Year 1 2 3 Expected...

XYZ has the following dividend forecast for the next three years: Year 1 2 3 Expected Dividend $1.00 2.00 2.50 After the third year, the dividend will grow at a constant rate of 5 percent per year. The required return is 10 percent. What is the value of the stock today?

Solutions

Expert Solution

As per dividend discount method, current value of stock is the present value of future dividend from stock.
Step-1:Calculation of Present value of next three years dividend
Year Dividend Discount factor@10% Present Value
a b c=1.10^-a d=b*c
1 $       1.00 0.9090909 $       0.91
2 $       2.00 0.8264463 $       1.65
3 $       2.50 0.7513148 $       1.88
Total $       4.44
Step-2:Calculation of present value of future dividend at the end of Year 3
Present Value 3 Years from now = D3*(1+g)/(Ke-g) Where,
= 2.50*(1+0.05)/(0.10-0.05) D3 $       2.50
= $    52.50 g 5%
Ke 10%
Step-3:Calculation of present value of step-2 value
Present Value = $    52.50 x (1.10^-3)
= $    52.50 x 0.751315
= $    39.44
Step-4:Calculation of present value of all dividend
Present Value = Present value of next three years dividend + Present Value of after three years dividend
= $       4.44 + $    39.44
= $    43.88
Thus,
Curent Value of stock is $    43.88

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