Question

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?

Answer 1

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

If you are having any doubts,please post a comment.

Thank you.please rate it.