Question

You are an analyst in charge of valuing common stocks. You have been asked to value two stocks. The first stock AB Inc. just paid a dividend of $12.00. The dividend is expected to increase by 40%, 35%, 25%, 20% and 10% per year respectively in the next five years. Thereafter the dividend will increase by 5% per year in perpetuity.

The second stock is CD Inc. CD will pay its first dividend of $15.00 per share in 5 years. The dividend will increase by 30% per year for the following 3 years after its first dividend payment. Thereafter the dividend will increase by 3% per year in perpetuity.

1. Calculate AB’s expected dividend for t = 1, 2, 3, 4, 5 and 6.
2. Calculate CD’s expected dividend for t = 1, 2, 3, 4, 5, 6, 7, 8 and 9.

If the required rate of return for both stocks is 12%,

3. What is AB’s stock price?
4. What is CD’s stock price?

Now assume that both stocks have a required rate of return of 50% per year for the first 2 years, 30% per year for the following 2 years, 20% per year for the subsequent 2 years and thereafter the required rate of return will be 12%. The required rates of return start with year 1.

5. What is AB’s stock price?
6. What is CD’s stock price?

(Hint: you may need to forecast more dividends than you did in parts a, and b.)

Note you cannot use the NPV function to immediately value the stocks at time 0, as the required rate of return changes during the forecast period.

Note: All calculations should be rounded to the nearest penny. That is 2 decimal places.

Answer 1

a) dividends are as follows for AB

yr 1= 16.8

yr 2= 22.6

yr3 = 28.35

yr4= 34.02

yr 5= 37.422

yr 6= 39.2931

b) dividends are as follows for CD

yr 1= 19.5

yr 2= 25.35

yr3 = 32.9550

yr4= 33.9437

yr 5= 34.9620

yr 6= 36.0108

yr 7=37.0911

yr 8= 38.2039

yr 9= 39.35

a) Price of AB= 414.6276

b) Price of CD = 329.5254