Question

Ten years ago, Pac Pac Toys began manufacturing and selling retro arcade games for sports bars. Dividends are currently $2.98 per share, having grown at a 12.00 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’ 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 19.00 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 @ 19%	Discounted Cash flow
1	12%	D0 ( 1+g)	$ 2.98( 1+0.12) =$ 3.3376	0.840336	$2.8047
2	12%	D1( 1+g)	$ 3.3376(1+0.12) =$ 3.7381	0.706165	$2.6397
3	6%	D2( 1+g)	$ 3.7381( 1+0.06) = $ 3.9624	0.593416	$2.3514
4	6%	D3( 1+g)	$ 3.9624(1+0.06) = $ 4.2001	0.498669	$2.0945
5	6%	D4( 1+g)	$ 4.2001( 1+0.06) = $ 4.4522	0.419049	$1.8657
5			$33.3928*	0.419049	$13.9932
			Total		$25.7492

Current share price is $ 25.7492

Here D0= Dividend in Year 0

D1= Dividend in Year 1, Dn = Dividend in Year n

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

Dividend in Year 6 = D5 ( 1+g)

= $ 4.4522( 1+0.05)

= $ 4.4522*1.05

= $ 4.675

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

PV of Dividend = D6 / ( Ke -g)

= $ 4.675/ ( 0.19-0.05)

= $ 4.675/0.14

= $ 33.3928.

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