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In: Finance

Phantom plans to pay annual dividends of $0.45, $0.60, and $0.75 a share in next three...

Phantom plans to pay annual dividends of $0.45, $0.60, and $0.75 a share in next three years, respectively. Afterwards, dividends are projected to increase by 1.5 percent per year. What is the market price of the stock today at a required return of 12.5 percent?

A.

$5.98
B.

$5.68
C.

$6.26
D.

$6.66
E.

$6.04

Solutions

Expert Solution

The correct answer is C. $6.26

This question is based on multiple period dividend discount model.

Re is the Required rate of return

g is the growth rate

Stage 1 - Calculation of Explicit Forecast period

Stage 2- Beyond 3 years

Expected dividend for the 4th year i.e. D4 = D3 * (1+g). Growth rate is 1.5%.

= $0.75 * (1 + 0.015)

= $0.75 * 1.015

= $0.7613

Horizon Price i.e. P3 = D4 / (Re-g)

= $0.7613 / (0.125 - 0.015)

= $0.7613 / 0.11

= $6.9209

Present Value of P3 = $6.9209 * 0.7023

= $4.861

Value of Stock = Stage 1 + Stage 2

= $1.4008 + $4.861

= $6.2618

Rounding to two decimal places

= $6.26

The market price of the stock today is $6.26

Note - How did we calculate the discounting factors @12.5%

Year 1 = 1/1.125

= 0.8889

Year 2 = 0.8889 /1.125

= 0.7901

Year 3 = 0.7901 / 1.125

= 0.7023

jeff jeffy answered 2 years ago
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