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Bayou Okra Farms just paid a dividend of $2.65 on its stock. The growth rate in...

Bayou Okra Farms just paid a dividend of $2.65 on its stock. The growth rate in dividends is expected to be a constant 4.5 percent per year indefinitely. Investors require a return of 15 percent for the first three years, a return of 13 percent for the next three years, and a return of 11 percent thereafter. What is the current share price?

Expert Solution

Calculation of current share price

Dividend for year 1(D1)=Last dividend(1+growth rate)

=$2.65(1+0.045)=$2.76925

D2=$2.76925(1+0.045)=$2.89386625

D3=$2.89386625(1+0.045)=$3.0241

D4=$3.0241(1+0.045)=$3.1601743

D5=$3.1601743(1+0.045)=$3.302382

D6=$3.302382(1+0.045)=$3.45099

First we need to calculate the share price at the end of year 6 as require rate of return is constant after year 6.

Share price at the end of year 6=D6(1+growth rate)/(Required rate of retrun-Growth rate)

=$3.45099(1+0.045)/(0.11-0.045)

=$55.4813

Now,calculate the share price at the end of year3 as follow:

Share price at the end of year 3=Present value of dividend of future dividend+Present value of share price at year6

=$3.1601743/(1+0.13)^1+$3.302382/(1+0.13)^2+($3.45099+$55.4813)/(1+0.13)^3

=$46.2259

Now,current share price is;

=Present value of dividend over 3 years+Present value of share price at the end of year 3

=$2.76925/(1+0.15)^1+$2.89386625/(1+0.15)^2+($3.0241+$46.2259)/(1+0.15)^3

=$36.98

jeff jeffy answered 2 years ago

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