Question

The CEO of ABC Corp believes that each share of ABC will pay a dividend of $2.40 at the end of the current year, $3.25 next year, and $4.40 the following year. After that dividends should grow at a steady rate of 10% a year for the following 5 years. Then the growth rate should drop to 3% for the foreseeable future.

a. Given an opportunity cost of 12% annually, what is the value of each ABC share?

b. What percent of share value is accounted for by the first three dividends?

(Manually Calculate)

Answer 1

Dividend for each year are:

Year	Dividend
1	2.4
2	3.25
3	4.4
4	4.4*1.10=4.84
5	4.48*1.10=5.324
6	5.324*1.10=5.8564
7	5.856*1.10=6.44204
8	6.44*1.10=7.086244
9	7.086*1.03=7.298831

Terminal value = Dividend next term/(Opportunity cost-terminal growth rate)
Opportunity cost = 0.12
Terminal growth rate = 0.03
Terminal value = 7.2998831/(0.12-0.03)=81.098

Hence the cash flow in year 8 = dividend+terminal value = 7.08+81.09=35.62

Present value of each year where year is n = Dividend/Cash flow/(1+r)^n, r=0.12 i.e opportunity cost

Calculating present values and summing up:

Year	Dividend			Present value
1	2.4			2.142857
2	3.25			2.59088
3	4.4			3.131833
4	4.84			3.075907
5	5.324			3.020981
6	5.8564			2.967034
7	6.44204			2.914052
8	7.086244	Terminal Value	81.09813	35.61619
9	7.298831
			Total	55.45973

We get value of each share = $55.46


B)Present value of first three dividends= 2.14+2.59+3.13=7.86
Percentage = 7.86/55.46= 14.18%