Question

You expect the Cochese Limited Group to increase dividends 20% for the next three years. Thereafter, g will settle to its long-run growth rate of 5%. If the required rate of return on the stock is 10% and the company just paid a dividend of $3.50, what is the current stock price? Include a timeline showing dividend payments in periods 1-4.

c) Assuming that you are correct about the Cochese Group dividend payout, what do you expect next period’s stock price to be? What will be your one-period total return from holding the stock between t=0 and t=1? Show how you derived your answers. Again, assuming you are correct about dividend payouts and nothing else changes, do you expect to earn this rate of return forever? Explain why or why not.

Answer 1

Statement showing dividends payment
Year	Growth in dividends	Dividends
0		3.5000
1	20%	4.2000	=3.5*120%
2	20%	5.0400	=4.2*120%
3	20%	6.0480	=5.04*120%
4	5%	6.3504	=6.048*105%

Required rate of return on the stock(k) = 10% or 0.10

Terminal growth rate = 5% or 0.05

Current price of the stock(P0) = Present value of the Future dividends + Present value of the Terminal value.

Terminal value at the end of 3 rd Year =

=>Terminal value at the end of 3 rd Year =

	A		B		A*B
Year	Cash flow		PVF@10%		PV of the cash flows
1	4.2000	Dividend	0.9090909091	=1/(1.1)^1	3.818
2	5.0400	Dividend	0.826446281	=1/(1.1)^2	4.165
3	6.0480	Dividend	0.7513148009	=1/(1.1)^3	4.544
3	127.008	Terminal value	0.7513148009	=1/(1.1)^3	95.423
	current stock price(P0)	$107.950

	A		B		A*B
Year	Cash flow		PVF@10%		PV of the cash flows
2	5.0400	Dividend	0.9090909091	=1/(1.1)^1	4.582
3	6.0480	Dividend	0.826446281	=1/(1.1)^2	4.998
3	127.008	Terminal value	0.826446281	=1/(1.1)^2	104.965
	Stock price after 1 year(P1)	114.545

Holding period Return = [(P1-P0+Dividend)] / [P0] * 100

holding period return between t-0 to t-1 = [(114.545-107.950+4.20)] / [107.950] * 100 = 10%

No the rate of return of 10% will not be same forever . Because the after 3 year the Growth rate will decrease to 5% and your Holding period return will be less than 10%.