Question

MMM Co. just paid a dividend of $1.10 per share. The dividend is expected to grow by 30% next year, 90% in both Years 2 & 3, 20% in Year 4, and then grow at a constant rate of 4% thereafter. The required rate of return is 5%. Compute the selling price of the stock.

Answer 1

Price of a stock is the present value of all future cash flows receivable from the stock discounted at required rate of return

D0 (Dividend for year 0, Current Year) = $1.10

D1 = D0 x (1 + Growth)

= $1.10 x 1.30

= $1.43

D2 = D1 x (1 + Growth)

= $1.43 x 1.90

= $2.72

D3 = D2 x (1 + Growth)

= $2.72 x 1.90

= $5.16

D4 = D3 x (1 + Growth)

= $5.16 x 1.20

= $6.19

Price of the stock at the end of year 4

= (D5) / (Re – G)

= [D4 x (1 + Growth)] / (Re – G)

= $6.19 x 1.04 / (0.05 – 0.04)

= $644.25

So, Price of the stock is the present value calculated in the following table:

Present value factor

= 1 / (1 + Re) ^ n

Where,

Re = 5% or 0.05

n = Years = 1 to 4

So, PV Factor for year 2 will be

= 1 / (1.05) ^ 2

= 1 / 1.1025

= 0.907029

Calculations	A	B	C = A x B
Year	Cash Flow	PV Factor	Present value
1	1.43	0.952381	1.36
2	2.72	0.907029	2.47
3	5.16	0.863838	4.46
4	6.19	0.822702	5.09
4	644.25	0.783526	504.79
		Price	518.17

So, the price of the stock is $518.17