A company has just paid its first dividend of $3.94. Next year's dividend is forecast to...

A company has just paid its first dividend of $3.94. Next year's dividend is forecast to grow by 9 percent, followed by another 9 percent growth in year two. From year 3 onwards dividends are expected to grow by 3.2 percent per annum, indefinetely. Investors require a rate of 14 percent p.a for investments of this type. The current price of the share is (round to nearest cent). a.$41.79, b.$38.19, c.$22.13, d.$21.84

Expert Solution

Step-1, Calculation of Dividend per share for the next 2 years

Dividend in Year 0 (D0) = $3.94 per share

Dividend in Year 1 (D1) = $4.2946 per share [$3.94 x 109%]

Dividend in Year 2 (D2) = $4.6811 per share [$4.2946 x 109%]

Step-2, Calculation of Stock Price for the Year 2 (P2)

Stock Price for the Year 2 = D2(1 + g) / (Ke – g)

= $4.6811(1 + 0.0320) / (0.14 – 0.0320)

= $4.8309 / 0.1080

= $44.73 per share

Step-3, Current price of the stock (P0)

As per Dividend Discount Model, the Value of the Stock is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 2

Year	Cash flow ($)	Present Value Factor (PVF) at 14.00%	Present Value of cash flows ($) [Cash flows x PVF]

1	4.2946	0.87719	3.77
2	4.6811	0.76947	3.60
2	44.73	0.76947	34.42

TOTAL			41.79

“Therefore, the current price of the share is (a). $41.79”

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 year

jeff jeffy answered 1 year ago

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