Question

a) Dora Inc.'s stock has a required rate of return of 12%, and it sells for $87.50 per share. The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-end dividend, D ₁?

	a.	$1.57
	b.	$2.48
	c.	$5.25
	d.	$7.92
	e.	$4.74

b) Ackert Company's last dividend was $3.00. The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (r _s) is 12.0%. What is the best estimate of the current stock price?

	a.	$88.03
	b.	$78.37
	c.	$91.22
	d.	$85.79
	e.	$71.71

Answer 1

a). Given about Dora Inc.,

Current stock price = $87.50

dividend growth rate g = 6%

The company's required return rs = 12%

So, value of stock today using constant dividend growth rate = D1/(rs-g)

So, 87.50 = D1/(0.12-0.06)

=> D1 = $5.25

Option c is correct.

b). Given about Ackert Company's,

last dividend D0 = $3

The dividend growth rate is expected to be constant at 1.5% for 2 years,

So, D1 = D0*1.015 = 3*1.015 = $3.045

D2 = D1*1.015 = 3.045*1.015 = $3.0907

thereafter which dividends are expected to grow at a rate of 8% forever.

g = 8%

If the firm's required return rs = 12%

So, value of stock at year 2 using constant dividend growth rate is

P2 = D2*(1+g)/(rs-g) = 3.0907*1.08/(0.12-0.08) = $83.4482

So, stock price today is sum of PV of future dividends and P2 discounted at rs

=> P0 = D1/(1+rs) + D2/(1+rs)^2 + P2/(1+rs)^2

=> P0 = 3.045/1.12 + 3.0907/1.12^2 + 83.4482/1.12^2 = $71.71

Current stock price = $71.71

option e is correct.