Eaton Inc. has decided to increase its annual dividends by 5 percent a year for the...

Eaton Inc. has decided to increase its annual dividends by 5 percent a year for the next three years and there would be no growth of dividends thereafter (i.e., the dividends remain the same indefinitely, from t=3). The company just paid a dividend of $2 per share. What is the market value of Eaton Inc. stock, if the required rate of return is 11%?

A. $18.1 B. $21 C. $23.5 D. $35

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Expert Solution

Hence, the correct answer is the second option i.e. option B. $21

D0 = 2

D1 = D0 x (1 + g) = 2 x (1 + 5%) = 2.10

D2 = D1 x (1 + g) = 2.10 x (1 + 5%) = 2.21

D3 = D2 x (1 + g) = 2.21 x (1 + 5%) = 2.32

Terminal value of all the dividends from year 3 till eternity, at the end of year 2, TV = D3 / Ke = 2.32/11% = 21.05

Hence, the market value of Eaton Inc. stock = PV of all the future dividends + PV of TV = D1/(1 + Ke) + D2 / (1 + Ke)² + TV / (1 + Ke)² = 2.10 / (1 + 11%) + 2.21 / (1 + 11%)² + 21.05 / (1 + 11%)² = 20.76 = 21

Hence, the correct answer is the second option i.e. option B. $21

jeff jeffy answered 2 years ago

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