Question

Hunter Petroleum Corporation paid a $2 dividend last year. The dividend is expected to grow at a constant rate of 5 percent forever. The required rate of return is 12 percent (this will also serve as the discount rate in this problem). (Use a Financial calculator to arrive at the answers.)

a. Compute the anticipated value of the dividends for the next three years. (Do not round intermediate calculations. Round the final answer to 3 decimal places.)

	Anticipated value
D1	$
D2	$
D3	$

b. Calculate the present value of each of the anticipated dividends at a discount rate of 12 percent. (Do not round intermediate calculations. Round the final answers to 3 decimal places.)

	PV of dividends
D1	$
D2
D3
Total	$

c. Compute the price of the stock at the end of the third year (P₃). (Round intermediate calculations to 2 decimal places. Round the final answer to 2 decimal places.)

P3	=	D4
		Ke − g

(D₄ is equal to D₃ times 1.05)

Price of the stock           $

d. Calculate the present value of the year 3 stock price at a discount rate of 12 percent. (Do not round intermediate calculations. Round the final answer to 3 decimal places.)

Price of the stock (discounted)           $

e. Compute the current value of the stock. (Do not round intermediate calculations. Round the final answer to 2 decimal places.)

Current value           $

f. Use formula given below to show that it will provide approximately the same answer as part e. (Round the final answer to 2 decimal places.)

P0	=	D1
		Ke − g

For formula 10–8, use D₁ = $2.10, K_e = 12 percent, and g = 5 percent. (The slight difference between the answers to parts e and f is due to rounding.)

Current value           $

Answer 1

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Answer:

= $2 (1 + 0.05)

= $2.1

= $2.1 (1 + 0.05)

= $2.205

= $2.205 (1 + 0.05)

= $2.315

Discount Rate

Since the future cash flow has to be discounted to the present value and the cash flows are different for different years, the Present Value factor table is to be used to determine the present value of the future dividends.

Present Value at 12% for 1 year = 0.893

Present Value at 12% for 2 year = 0.797

Present Value at 12% for 3 year = 0.712

Present Value of D₁ = $2.1 (0.893)

= $1.875

Present Value of D₂ = $2.205 (0.797)

= $1.757

Present Value of D₃ = $2.315 (0.712)

= $1.648

Step 1: Calculation of D ₄:

D₃ =$2.315

g = 5.00%

It is assumed that the Growth Rate remains constant at for determining the value of D₄.

D₄ = $2.431

Step 2: Calculation of Stock Price:

Where,

D₄ = Dividend per share at the end of 4^th year

K_e = Required Rate of Return

g = Growth

P₃ = Price of common stock at end of 3^rd year

Discount Rate

It is the single cash flow, which has to be discounted to the present value. The Present Value factor table is used to discount the Future cash flow to the Present cash flow.

The discount rates for =.

Present Value of

Total Present value of all future dividends

Where,

D₁ = Dividend per Share at the end of 1^st year

K_e = Required Rate of Return

g = Growth

P₀ = Price of Common Stock

D₁