Question

Gentry Can Company's (GCC) latest annual dividend of $1.45 a share was paid yesterday and maintained its historic 6 percent annual rate of growth. You plan to purchase the stock today because you believe that the dividend growth rate will increase to 8 percent for the next three years and the selling price of the stock will be $41 per share at the end of that time. How much should you be willing to pay for the GCC stock if you require a 12 percent return? Do not round intermediate calculations. Round your answer to the nearest cent. $   What is the maximum price you should be willing to pay for the GCC stock if you believe that the 8 percent growth rate can be maintained indefinitely and you require a 12 percent return? Do not round intermediate calculations. Round your answer to the nearest cent. $   If the 8 percent rate of growth is achieved, what will the price be at the end of Year 3, assuming the conditions in Part b? Do not round intermediate calculations. Round your answer to the nearest cent. $

Answer 1

Answer a.

Last Dividend, D0 = $1.45
Price in 3 years, P3 = $41.00
Required Return, rs = 12.00%

Growth rate for next 3 years is 8%

D1 = $1.4500 * 1.08 = $1.5660
D2 = $1.5660 * 1.08 = $1.69128
D3 = $1.69128 * 1.08 = $1.8265824

Current Price, P0 = $1.566/1.12 + $1.69128/1.12^2 + $1.8265824/1.12^3 + $41.00/1.12^3
Current Price, P0 = $33.23

Answer b.

Last Dividend, D0 = $1.45
Growth Rate, g = 8.00%
Required Return, rs = 12.00%

D1 = $1.4500 * 1.08 = $1.5660

Current Price, P0 = D1 / (rs - g)
Current Price, P0 = $1.566 / (0.12 - 0.08)
Current Price, P0 = $1.566 / 0.04
Current Price, P0 = $39.15

Answer c.

Last Dividend, D0 = $1.45
Growth Rate, g = 8.00%
Required Return, rs = 12.00%

D1 = $1.4500 * 1.08 = $1.5660
D2 = $1.5660 * 1.08 = $1.69128
D3 = $1.6913 * 1.08 = $1.8266
D4 = $1.8266 * 1.08 = $1.9727

Price in 3 years, P3 = D4 / (rs - g)
Price in 3 years, P3 = $1.9727 / (0.12 - 0.08)
Price in 3 years, P3 = $1.9727 / 0.04
Price in 3 years, P3 = $49.32