Question

A firm oays an annual dividend and you just missed the annual dividend of 2.50/share you expect dividend will grow at 10%/yr for 5yrs abd slow to 3% after. Required rate us 8% what is the following?

A. value of D1 in super normal growth

B. value of D6 in super normal growth

C. value od D6 in perpetuity phase

D. what should you be willing to pay today

Answer 1

A. value of D1 in super normal growth

D1 = D0*(1+g)

= 2.5*1.1

= $2.75/share

B. value of D6 in super normal growth

D6 = 2.5*1.1^5*1.03

= 4.14706325

=  $4.15/share

C. value of D6 in perpetuity phase

Using Gordon Growth Model

P5 = D6 / (Ke – g)

Where,

P5 - Market price at the end of year 5 = ?

D6 - Expected dividend in year = 4.15

Ke – Cost of equity= 8%

G – Growth rate in dividend = 3%

P5 = 4.14706325/(.08-.03)

= 4.14706325/.05

= $82.94

D. what should you be willing to pay today

Computing current share price by discounting the cashflow at required return

Year	Dividend	PVF@8%	Present Value (Cashflow*PVF)
1	2.75	0.926	2.55
2	3.03	0.857	2.59
3	3.33	0.794	2.64
4	3.66	0.735	2.69
5	86.97(3.66*1.1+82.94)	0.681	59.19

current share price = Cashflow*PVF

= 2.55+2.59+2.64+2.69+59.19

= $69.66