Question

A share is expected to pay a dividend of $2 in 1 year and $3 in 2 years. Then the dividend will grow at 8% p.a. until the end of year 4. After that, the growth rate would become 3% p.a. forever. The rate of return is 11% p.a. effective. Using the dividend discount model (DDM), calculate the value of the share today. (Round your answer to the nearest cent.)

Answer 1

Dividend Year 1(D1) =2
Dividend Year 2(D2) =3
Growth rate for year 3 and year 4(g) = 8%

 

D3 = D2*(1+g) 

      = 3*(1+8%) 

      = 3.24

 

D4 = D3*(1+g) 

      = 3*(1+8%)^2 

      = 3.4992

 

Growth Forever(g2) =3%

 

Terminal Value = D4*(1+g2)/(r-g2) 

                            = 3.4992*(1+3%)/(11%-3%) 

                            = 45.0522

 

Value of share today = D1/(1+r)+D2/(1+r)^2+D3/(1+r)^3+D4/(1+r)^4+Terminal Value/(1+r)^4
                                      = 2/(1+11%)+3/(1+11%)^2+3.24/(1+11%)^3+3.4992/(1+11%)^4+45.0522/(1+11%)^4 

                                      = 38.59

Value of share today = 38.59