Question

You’ve collected the following information from your favorite financial website.

52-Week Price Stock (Cur div)

Hi Lo Div Yld % PE Ratio Close Price Net Chg

77.40 10.43 Palm Coal .36 2.6 6 13.90 –.24

55.81 33.42 Lake Lead Grp 1.54 3.8 10 40.43 –.01

130.95 69.60 SIR 2.10 2.4 10 88.99 3.07

50.24 13.95 DR Dime .80 5.2 6 15.43 –.26

35.00 20.74 Candy Galore .32 1.5 28 ?? .18

According to your research, the growth rate in dividends for SIR for the next five years is expected to be 20.5 percent. Suppose SIR meets this growth rate in dividends for the next five years and then the dividend growth rate falls to 5.5 percent indefinitely. Assume investors require a return of 13 percent on SIR stock.

According to the dividend growth model, what should the stock price be today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Current stock price $

Answer 1

Step-1, Dividend per share for the next 5 years

Dividend in Year 0 (D0) = $2.10 per share

Dividend in Year 1 (D1) = $2.5305 per share [$2.10 x 120.50%]

Dividend in Year 2 (D2) = $3.0493 per share [$2.5305 x 120.50%]

Dividend in Year 3 (D3) = $3.6743 per share [$3.0493 x 120.50%]

Dividend in Year 4 (D4) = $4.4276 per share [$3.6743 x 120.50%]

Dividend in Year 5 (D5) = $5.3352 per share [$4.4276 x 120.50%]

Step-2, Calculation of Stock Price for the Year 5 (P5)

Dividend Growth Rate after 5th year (g) = 5.50%

Required Rate of Return (Ke) = 13.00%

Stock Price for the Year 5 = D5(1 + g) / (Ke – g)

= $5.3352(1 + 0.0550) / (0.13 – 0.0550)

= $5.6287 / 0.0750

= $75.05 per share

Step-3, The Current Stock Price

The Current Stock Price is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 5

Year	Cash flow ($)	Present Value factor at 13%	Present Value of cash flows ($)
1	2.5305	0.88496	2.24
2	3.0493	0.78315	2.39
3	3.6743	0.69305	2.55
4	4.4276	0.61332	2.72
5	5.3352	0.54276	2.90
5	75.05	0.54276	40.73
TOTAL			53.52

“Hence, the current stock price will be $53.52”

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.