Question

Your broker recommends that you purchase XYZ Inc. at $60. The stock pays a $2.40 dividend which is expected to grow annually at 8 percent. If you want to earn 12 percent on your funds, is this a good buy?

(ii) Presently, Stock A pays a dividend of $2.00 a share, and you expect the dividend to grow rapidly for the next four years at 20 percent. Thus the dividend payments will be
       Year      Dividend
         1        $1.20
         2         1.44
         3         1.73
         4         2.07

After this initial period of super growth, the rate of increase in the dividend should decline to 8 percent. If you want to earn 12 percent on investments in common stock, what is the maximum you should pay for this stock?

Please show work and how you get the numbers

Answer 1

Ans 1	we have to compute the required rate based on the existing price
	required rate =	2.4*108%/60+8%
		12.32%
	This means stock is offering 12.32% return and our required return is 12%
	therefore its good buy
Ans 2	Computation of value of stock
		i	ii	iii	iv	v=iv*iii
	year	Dividend	Terminal value	Total cash flow	PVIF @ 12%	Present value
	1	1.2		1.2	0.892857143	$          1.07
	2	1.44		1.44	0.797193878	$          1.15
	3	1.73		1.73	0.711780248	$          1.23
	4	2.07	55.89	57.96	0.635518078	$        36.83
	Total					$        40.29
	Terminal value =	2.07*108%/(12%-8%)
		55.89
	Therefore price today =			$           40.29