The Central Heating Company paid common stock dividend of $2.25 in 2016, $2.50 in 2017, $2.65...

The Central Heating Company paid common stock dividend of $2.25 in 2016, $2.50 in 2017, $2.65 in 2018, and its most recent dividend was $2.85. The company expects no dividend growth in this year due to the corona pandemic. However, it expects a 15% dividend growth over 2019 dividend in years 2021 and 2022, then 10% growth in 2023. Starting in year 2024, the company wishes to continue constant dividend growth indefinitely. What is the value of the company's stock if the required rate of return is 12 percent? Will you buy the share of the central heating company if it sells for $40 in the market? *

Hint: To find constant growth rate, use the historical dividends that are paid.

Expert Solution

constant dividend growth rate = (recent dividend paid/dividend paid in 2016)^{1/no. of years} - 1

constant dividend growth rate = ($2.85/$2.25)^1/3 - 1 = 1.2666666666666666666666666666667^{0.33333333333333333333333333333333} - 1 = 1.0820 - 1 = 0.0820 or 8.2%

the value of the company's stock if the required rate of return is 12 percent is $92.91.

you will buy the share of the central heating company if it sells for $40 in the market because it is undervalued. market price of $40 is lower than its value of $92.91.

Years	2020	2021	2022	2023	2024
required rate of return	12.00%	12.00%	12.00%	12.00%	12.00%
Dividend growth rate	0	15.00%	15.00%	10.00%	8.20%
Dividend per share	$0.00	$3.28	$3.77	$4.15	$4.49
Terminal value	$0.00	$0.00	$0.00	$118.05	$0.00
PV of dividends and terminal value	$0.00	$2.93	$3.00	$86.98	$0.00
Value of stock	$92.91

Terminal value is the present value of dividends for year 2024 and beyond. it is calculated at the end of year 2023. so, it will be discounted for 3 years only.

Calculation

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