Question

Question 1

You are trying to value the stock of Cowbell Inc. You know that the firm only uses dividends to return cash to its investors and you have forecasted the dividends for the 4 years (see table below). You believe that dividends will grow at a constant rate of 2% each year after year 4. The cost of equity is 13%. Given this information estimate the share price for Cowbell Inc. Round your answer to two decimals (do not enter the $-symbol in your answer).

Dividend Forecasts

	Year
	1	2	3	4
Dividend per Share (in $)	1.5	2	1.2	1.9

Question 2

Crane Inc. currently only returns cash to its investors in the form of dividends. It pays out 50% of its earnings per share. The return on new investment for Crane is 12.7%. Given this information, estimate the growth rate for the future dividends of Crane. Express your result in percent and round to two decimals (do not include the %-symbol in your answer).

Answer 1

Answer 1:

Calculation of Current Share Price Using Dividend Discount Model:

Present value of the stock = [D₁ / (1 + r)¹] + [D₂ / (1 + r)²] + [D₃ / (1 + r)³] + [D₄ / (1 + r)⁴] + [Perpetuity Value / (1 + r)⁴]

D₁ = $1.5

D₂ = $2

D₃ = $1.2

D₄ = $1.9

r = cost of equity = 13% or 0.13

After Year 4 dividends are expected to grow @ 2% per year forever, therefore for that we need to find out the perpetuity value at the end of year 4.

Perpetuity Value = (D₄ * ( 1+growth rate)) / (cost of equity - growth rate)

= $1.938 / 0.11

= $17.62

Present value of the stock = [$1.5 / (1 + 0.13)¹] + [$2 / (1 + 0.13)²] + [$1.2 / (1 + 0.13)³] + [$1.9 / (1 + 0.13)⁴]+ [$17.62 / (1 + 0.13)⁴]

= $1.33 + $1.57 + $0.83 + $1.17 + $10.81

=$15.71

Present Value of stock today = $15.71

Answer 2:

Growth Rate = Retention Ratio * Return on Investment

Retention Ratio = 1 - Dividend Payout Ratio

= 1 - 0.50

= 0.50 or 50%

Return on Investment = 12.7% or 0.127

Therefore Growth Rate = 0.50 * 0.127

= 0.0635

Therefore Growth Rate of Crane Inc. in Percentage terms = 0.0635 * 100 = 6.35