Question

Phoenix industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the first dividend since the crisis. Analysts expect dividend to increase by 50 percent a year for another 2 years. Then they expect dividends to increase by 20 percent a year for another 2 years. After the fifth year dividend growth is expected to settle down to a more moderate long-term growth rate of 6%. If the firm’s investors expect to earn a return of 14% of his stock, what must be its price?

Answer 1

DIVIDEND

D1

YEAR 1

1 $

D2

YEAR 2

1*1.5 =

1.50

$

D3

YEAR 3

1.5*1.5 =

2.25

$

D4

YEAR 4

2.25*1.2 =

2.70

$

D5

YEAR 5

2.7*1.2 =

3.24

$

D6

YEAR 6

3.24*1.06 =

3.43

$

PRICE AT YEAR 6 =

DIVIDEND AT YEAR 6* GROWTH RATE

COST OF EQUITY (KE) - GROWTH RATE

=

3.43 * 1.06

0.14 - 0.06

45.45 $

PRICE AT YEAR 0=

D1

+

D2

+

D3

+

D4

+

D5

+

D6

+

P6

(1+KE)

(1+KE)2

(1+KE)3

(1+KE)4

(1+KE)5

(1+KE)6

(1+KE)6

=

1

+

1.5

+

2.25

+

2.7

+

3.24

+

3.43

+

45.45

(1+0.14)

(1+0.14)2

(1+0.14)3

(1+0.14)4

(1+0.14)5

(1+0.14)6

(1+0.14)6

=

29 $