Question

Question 1

Aluworks Co. is expected to pay a $21.00 dividend next year. The dividend will decline by 10 percent annually for the following three years. In year 5, Aluworks will sell off assets worth $100 per share. The year 5 dividend, which includes a distribution of some of the proceeds of the asset sale, is expected to be $60. In year 6, the dividend is expected to decrease to $40 and will be maintained at $40 for one additional year. The dividend is then expected to grow by 5 percent annually thereafter. If the required rate of return is 12 percent, what is the value of one share of Aluworks?

Answer 1

You need to calculate the stock price.

Price of any security today is the present value of all the incomes that security is going to generate in future discounted at required rate of return.

There is widely used formula to calculate the price of share whose dividend is contant, called gordan growth formula

GGn formula =

P0 = Price today , D1= Expected dividend , Ke = cost of capital , g is growth

Given Information

Dividends as per detials given in the question:

Year	Dividends
1	21.0000
2	21x0.90=18.9000
3	18.90x0.90=17.0100
4	17.01x0.90=15.3090
5	60.0000
6	40.0000
7	40.0000

Growth after 7 year = 5% , Expeted rate of return = 12%

Calculate the price of share at Time 6 with gordan growth as growth is constant from year 7 and onwards

P6 = D7 / ( Ke - G7)

= 40 / ( 0.12 - 0.05)

= 40 / 0.07

Price at Time 6 = 571.42857 approx

Now calculate the Present value of Dividend 1 to 6 and Price at Time 6

PV =

= 18.75 + 15.06696429 + 12.10738202 + 9.72914626 + 34.04561134 + 20.26524485 + 289.5034971

= 399.4678

Price of share = $399.47 approx.