Question

The dividend for Should I, Inc., is currently $1.70 per share. It is expected to grow at 12 percent next year and then decline linearly to a perpetual rate of 3 percent beginning in four years. If you required a return of 16 percent on the stock, what is the most you would pay per share? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Step-1, Dividend for the next 4 years

Dividend in Year 0 (D0) = $1.70 per share

Dividend in Year 1 (D1) = $1.9040 per share [$1.70 x 112%]

Dividend in Year 2 (D2) = $2.1325 per share [$1.9040 x 112%]

Dividend in Year 3 (D3) = $2.3884 per share [$2.1325 x 112%]

Step-2, The Price of the stock in year 3 (P3)

The Share Price in year 3(P3) = D3(1 + r) / (Ke – g)

= $2.3884(1 + 0.03) / (0.16 – 0.03)

= $2.4600 / 0.13

= $18.92 per share

Step-3, Current Price per share

As per Dividend Discount Model, The Current Price per share is the aggregate of the Present Value of the future dividend payments and the present value the share price in year 3

Year	Cash flow ($)	Present Value factor at 16.00%	Present Value of cash flows ($)
1	1.9040	0.86207	1.64
2	2.1325	0.74316	1.58
3	2.3884	0.64066	1.53
3	18.92	0.64066	12.12
TOTAL			16.88

“Hence, the Price per share will be $16.88”

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.