Question

The Fijian Holding Limited’s last dividend was $1.25 and the directors expect to maintain the historic 4 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7 percent for the next three years and the stock will then reach $25.00 per share.

i. How much should you be willing to pay for the stock if you require a 16 percent return? (2Marks)

ii. How much should you be willing to pay for the stock if you feel that the 7 percent growth rate can be maintained indefinitely and you require a 16 percent return?

Answer 1

i) We sholud be willing to pay $ 6.73 for the stock if the required rate of return is 16% .

here we have used the dividend growth model

First we find out each year dividend and the used 4th year devidend to find the value of share at the end of 4th year after dividend and then discounted the calue to get the presesnt value.

Same, strategy is use for (ii) when the growth rate is 7%

then the amount which we should be willing to pay is $10.05

Particulars
i)Last dividend	1.25
Growth rate	4%
Required rate of capital	16%
Years	0	1	2	3	4
Dividevd	1.25	1.3	1.35	1.41	1.46	E6*(1+$B$3)
Dividend at the end of 4th years	1.46
Value of share at the end od 4th year	Dividend/(required rate of return-growth rate)
	12.19	B7/(B4-B3)
Present value of share	6.73	B9/(1+16%)^4
ii) If the growth rate is 7%
Last dividend	1.25
Growth rate	7%
Required rate of capital	16%
Years	0	1	2	3	4
Dividevd	1.25	1.3375	1.43	1.53	1.64	E17*(1+$B14)
Dividend at the end of 4th years	1.64
Value of share at the end od 4th year	Dividend/(required rate of return-growth rate)
	18.21	B7/(B4-B3)
Present value of share	10.05	B9/(1+16%)^4

Please refer to the attached file for steps, explanation and calculation along with formula and cell referred.