Question

Diets For You announced today that it will begin paying annual dividends next year. The first dividend will be $0.12 a share. The following dividends will be $0.15, $0.20, $0.50, and $0.75 a share annually for the following 4 years, respectively. After that, dividends are projected to increase by 4 percent per year. How much are you willing to pay to buy one share of this stock today if your desired rate of return is 8.5 percent?

Answer 1

we have to use dividend discount model to compute the terminal value
Price today is the present value of future cash flow
i	ii	iii=i+ii	iv	v	vi=iv*v
year	Dividend	Terminal value	total cash flow	PVIF @ 8.5%	present value
1	0.1200		0.12	0.9217	0.11
2	0.1500		0.15	0.8495	0.13
3	0.2000		0.20	0.7829	0.16
4	0.5000		0.50	0.7216	0.36
5	0.7500	17.33	18.08	0.6650	12.03
					12.78
Terminal value = Divided in year 6/(required rate - growth rate)
		0.75*104%/(8.5%-4%)
		17.33
Price today =				$        12.78
Ans =					$        12.78