Question

CEPS Group is going to pay an annual dividend of OMR 4.01 a share on its common stock next year. This year, the company paid a dividend of OMR 3.75 a share. The company adheres to a constant rate of growth dividend policy. What will one share of this common stock be worth five years from now if the applicable discount rate is 9.25 percent?

Answer 1

First we will calculate the growth rate of dividend as per below:

Here we will use the following formula:

FV = PV * (1 + r%)n

where, FV = Future value = 4.01, PV = Present value = 3.75, r = growth rate, n= time period = 1

now, putting theses values in the above equation, we get,

4.01 = 3.75 * (1 + r)1

4.01 / 3.75 = (1 + r)1

4.01 / 3.75 = 1 + r

1.0693333 = 1 + r

r = 1.0693333 - 1

r = 0.069333 or 6.933%

So, growth rate of dividends is 6.933%

For calculating the share price 5 years from now, we will amend the formula to below:

Share price (after 5 years) = D6 / k -g

where, D6 is the dividend after 6 years, k is discount rate and g is growth rate.

First we will calculate dividend after 5 years. Dividend will grow at the rate of 6.933% annually. So we will calculate the D6 by future value formula as per below:

FV = P * (1 + r)5

where, FV = Future value, which is the dividend after 5 years,  P is next years' dividend = $3.75, r is the rate of interest = Growth rate = 6.933% and n is 5 years

Now, putting these values in the above formula, we get,

FV = $3.75 * (1 + 6.933%)5

FV = $3.75 * (1 + 0.06933)5

FV = $3.75 * (1.06933)5

FV = $3.75 * 1.39818785191

FV = $5.24

So, the value of D6 is $5.24

Now, we will calculate the share price after 5 years by putting the values in the below formula:

Share price (after 5 years) = D6 / k -g

Share price (after 5 years) = $5.24 / 9.25% - 6.933%

Share price (after 5 years) = $5.24 / 2.317%

Share price (after 5 years) = $226.15