Question

OMG Corporation just paid a $2.10 annual dividend on each share. It is planning on increasing its dividend by 21 percent a year for the next 4 years. The corporation will then decrease the growth rate to a rate of 6 percent per year, and keep it that way indefinitely. The required rate of return is 7.60 percent. Calculate the current value of one share of this corporation's stock.

Answer 1

Step-1, Calculation of Dividend per share for the next 4 years

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

Dividend in Year 1 (D1) = $2.5410 per share [$2.10 x 121%]

Dividend in Year 2 (D2) = $3.0746 per share [$2.5410 x 121%]

Dividend in Year 3 (D3) = $3.7203 per share [$3.0746 x 121%]

Dividend in Year 4 (D4) = $4.5015 per share [$3.7203 x 121%]

Step-2, Calculation of Stock Price for the Year 4 (P4)

Stock Price for the Year 4 = D4(1 + g) / (Ke – g)

= $4.5015(1 + 0.06) / (0.0760 – 0.06)

= $4.7716 / 0.0160

= $298.23 per share

Step-3, Value of the Stock

As per Dividend Discount Model, the Value of the Stock is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 4

Year	Cash flow ($)	Present Value factor at 7.60%	Present Value of cash flows ($)
1	2.5410	0.92937	2.36
2	3.0746	0.86372	2.66
3	3.7203	0.80272	2.99
4	4.5015	0.74602	3.36
4	298.23	0.74602	222.48
\TOTAL			233.85

“Hence, the current value of one share of this corporation's stock will be $233.85”

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.