Question

Integrated Potato Chips paid a $1 per share dividend yesterday. You expect the dividend to grow steadily at a rate of 4% per year.

A- waht is the expected dividened in each of the next 3 years ?

B- if the discount rate for the stock is 12 %, at what price will the stock sell?

C- what is the expected stock price 3 years from now ?

D- if you buy the stock and paln to sell it 3 years from now , what are your expected cash flows in (i)year 1; (ii) year 2; (iii) year 3?

E- what is the persent value of the stream of payments you found in part (d) compare your answaer to par (B)

Answer 1

The dividends are expected to grow at 4% growth rate.

Recently paid dividend = $1

A. Dividend in Year 1, 2 and 3

Div (Year 1) = 1 * (1 + 4%) = 1.04

Div (Year 1) = 1.04 * (1 + 4%) = 1.0816

Div (Year 1) = 1 * (1 + 4%) = 1.124864

B- if the discount rate for the stock is 12 %, at what price will the stock sell?

We will use constant growth dividend discount model here:

Price of stock today = 1.04/(12% - 4%) = $13

C- what is the expected stock price 3 years from now ?

Price at year 3 = Div(Year 4)/ (r - g)

Div (Year 4) = 1.169859

Price at Year 3 = 1.169859/(12% - 8%) = $14.623

D- if you buy the stock and paln to sell it 3 years from now , what are your expected cash flows in (i)year 1; (ii) year 2; (iii) year 3?

Cashflow in Year 0 = -13 (Purchase price - negative sign indicated cashoutflow)

Cashflow in Year 1 = 1.04 (Dividend in Year 1)

Cashflow in Year 2 = 1.0816

Cashflow in Year 3 = 1.1244864 + 14.623 (Dividend in year 3 + Selling price) = 15.748

E) PV of these cashflows:

PV = $13 --> Stock price today