Question

*Please do not answer if you've already did. I'm getting a second opinion on this.

MBA Inc is expected to have dividend distribution policies as below:
- MBA Inc will pay out cash dividend £1 per share per year in the next two years
- In the end of the 3rd year, MBA Inc will pay out cash dividend £2 per share
- From the end of the 3rd year, MBA Inc will continuously pay cash divided at 5% constant growth rate per annum.

What is the theoretical price of stock of MBA Inc if the required rate of return is 10% per annum? Please show your working.

Answer 1

Information given in the question is:

Particulars	Year 1	Year 2	Year 3	Perpetuity
Dividend paid per share p.a	1£	1£	2£
growth rate				5%
Required rate of return	10%	10%	10%	10%

Now, Present Value of Dividend paid in year 1=Dividend/(1+r)=1£/(1+0.1)=£0.909

Present Value of Dividend paid in year 2=Dividend/(1+r)^2=1£/(1+0.1)^2=£0.826

Present Value of Dividend paid in year 3=Dividend/(1+r)^3= 2£/(1+0.1)^3=£1.5

Calculation of Present Value of stock in perpetuity using dividend discount model,

where p0 is Price of stock in perpetuity

d0= previous year dividend

g is growth rate

ke is required rate of return

£

Now, Present Value of Stock= Dividend of 1st year + dividend of 2nd year+ dividend of 3rd year + Price of stock in perpetuity

PV of stock= 0.909+0.826+1.5+31.5= £34.735

the theoretical price of stock of MBA Inc if the required rate of return is 10% per annum is £34.735