Question

CEPS Group announced today that it will begin paying annual dividends next year. The first dividend will be OMR 0.65 a share. The following dividends will be OMR 0.72, OMR 0.85, OMR 0.89, and OMR 0.95 a share annually for the following 4 years, respectively. After that, dividends are projected to increase by 4 percent per year. How much are you willing to pay to buy one share of this stock today if your desired rate of return is 11.5 percent?  show the answer in detail.

Answer 1

Step-1, Dividend for the next 5 years

Dividend in Year 1 (D1) = 0.65

Dividend in Year 2 (D2) = 0.72

Dividend in Year 3 (D3) = 0.85

Dividend in Year 4 (D4) = 0.89

Dividend in Year 5 (D5) = 0.95

Step-2, Share Price in Year 5 (P5)

Dividend in Year 5 (D5) = 0.95 per share

Dividend Growth Rate after Year 5 (g) = 4.00% per year

Required Rate of Return (Ke) = 11.50%

Share Price in Year 5 (P5) = D5(1 + g) / (Ke – g)

= 0.95(1 + 0.04) / (0.1150 – 0.05)

= 0.9880 / 0.0750

= 13.17 per share

Step-3, The Current Stock Price

As per Dividend Discount Model, Current Stock Price the aggregate of the Present Value of the future dividend payments and the present value the share price in year 5

Year	Cash flow	Present Value Factor (PVF) at 11.50%	Present Value of cash flows [Cash flows x PVF]
1	0.65	0.89686	0.58
2	0.72	0.80436	0.58
3	0.85	0.72140	0.61
4	0.89	0.64699	0.58
5	0.95	0.58026	0.55
5	13.17	0.58026	7.64
TOTAL			10.55

Hence, the Current price of the share will be 10.55

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.