Question

 Over the past 6​ years, Elk County Telephone has paid the dividends shown in the following​ table. he​ firm's dividend per share in

2020 is expected to be $1.27

2019 $1.22

2018 $1.17

2017 $1.12

2016 $1.08

2015 $1.04

2014 $1.00

a.  If you can earn 11​% on​ similar-risk investments, what is the most you would be willing to pay per share in 2019​, just after the $1.22 dividend?

b.  If you can earn only 8% on​ similar-risk investments, what is the most you would be willing to pay per​ share?

c.  Compare your findings in parts a and ​b, what is the impact of changing risk on share​ value?

Answer 1

Hello Sir/ Mam

The table for dividend you provided is not quite representative of the dividend growth rate. I am expecting that it want to say something like this:

2014	1
2015	1.04
2016	1.0816
2017	1.124864
2018	1.169859
2019	1.216653
2020	1.265319

which also comes same as you table after rounding off. Hence, here we can easily see that dividend growth rate = 4%.

Now,

(a) Required answer = $18.08

Here, Dividend expected next year = $1.27

Required rate = 11%

growth rate = 4%

Hence,

(b) Required answer = $31.63

Here, Dividend expected next year = $1.27

Required rate = 8%

growth rate = 4%

Hence,

(c) On comparing findings in a and b, we can conclude that when risk was high, we were willing to pay less for same cashflows, whereas now, when risk of holding that security has fallen, we are willing to pay more for same cashflows. Hence, with high risk, share value remains low, whereas with lower risk, share value becomes high.

I hope this solves your doubt.

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