Question

In: Finance

Ten years ago, Pac Pac Toys began manufacturing and selling retro arcade games for sports bars....

Ten years ago, Pac Pac Toys began manufacturing and selling retro arcade games for sports bars. Dividends are currently $2.28 per share, having grown at a 13.00 percent compound annual rate over the past 5 years. That growth rate is expected to be maintained for the next 2 years, after which dividends are expected to grow at half that rate for 3 years. Beyond that time, Pac Pac Toys’s dividends are expected to grow at 5.00 percent per year. What is the current value of a share of Pac Pac Toys common stock if your required return is 22.00 percent?

Solutions

Expert Solution

Computation of Current Value of share

We know that Current share price reflects present value of future Cash flows

For a Shareholders future cash flows are nothing but dividend amount

Current value of a share = Present value of Dividend payments

Year Growth rate in Dividend Dividend calculation Dividend Amount Discounting factor @ 22% Discounted Cash flow( Cash flow* Dividend)
1 13.0% D0 ( 1+g) $ 2.28( 1+0.13) =$ 2.5764 0.819672 $2.1118
2 13.0% D1( 1+g) $ 2.5764(1+0.13) =$ 2.9113 0.671862 $1.9560
3 6.5% D2( 1+g) $ 2.9113( 1+0.065) = $ 3.1006 0.550707 $1.7075
4 6.5% D3( 1+g) $ 3.1006(1+0.065) = $ 3.3021 0.451399 $1.4906
5 6.5% D4( 1+g) $ 3.3021( 1+0.065) = $ 3.5167 0.369999 $1.3012
5 $27.5000* 0.369999 $10.1750
Total $18.7421

Current share price is $ 18.4721

Computation of PV of Dividend accruing fro Year 6 to infinity at year end 5

Dividend in Year 6 = D5 ( 1+g)

= $ 3.5167( 1+0.05)

= $ 3.5167*1.05

= $ 3.6925

PV of Dividend = D6 / ( Ke -g)

= $ 3.6925/ ( 0.22-0.05)

= $ 4.675/0.17

= $ 27.5

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