Question

1) Far Side Corporation is expected to pay the following dividends over the next four years: $14, $10, $8, and $4. Afterward, the company pledges to maintain a constant 5 percent growth rate in dividends forever.

Required: If the required return on the stock is 12 percent, what is the current share price?

2) Marcel Co. is growing quickly. Dividends are expected to grow at a 25 percent rate for the next 3 years, with the growth rate falling off to a constant 7 percent thereafter.

Required: If the required return is 13 percent and the company just paid a $3.50 dividend. what is the current share price?

3) Metroplex Corporation will pay a $5.10 per share dividend next year. The company pledges to increase its dividend by 7.00 percent per year indefinitely.

Required: If you require an 12.20 percent return on your investment, how much will you pay for the company's stock today?

Answer 1

Question 1

Step 1: Computation of market price at the end of year 4 using Gordon Growth Mdel

P₄ = D₅ / (Ke-g)

= (4*1.05) / (0.12 - 0.05)

= $60

Step 2: Computing current share price by discounting the cashflow at required return

Year	Dividend	PVF@12%	Present Value (Cashflow*PVF)
1	14	0.893	12.50
2	10	0.797	7.97
3	8	0.712	5.70
4	64 (4+60)	0.636	40.70

current share price = $66.87 (12.50+7.97+5.70+40.70)

Question 2

Step 1: Computation of market price at the end of year 3 using Gordon Growth Mdel

P₃ = D₄ / (Ke-g)

= *7.31 / (.13 - .07)

= $121.83

* 7.31 = (3.5 * 1.25³ * 1.07)

Step 2: Computing current share price by discounting the cashflow at required return

Year	Dividend	PVF@13%	Present Value (Cashflow*PVF)
1	4.38	0.885	3.88
2	5.47	0.783	4.28
3	128.67 (6.84+121.83)	0.693	89.17

Current Share Price = $97.33(3.88+4.28+89.17)

Question 3

Using Gordon Growth Model

P₀ = D₁ / (Ke-g)

Where

D₁ - DPS next year

Ke - required return

g - Growth rate in dividend

P₀ - Current market price

P₀ = D₁ / (Ke-g)

= 5.10/ (.122-.07)

= $98.08