In: Finance
CHERCRO Inc. is a startup. It is estimated that the company will
not be paying any dividends for the coming 4 years. If the company
distributes $3 per share 5 years from today, the growth rate of the
dividends will be 2% per year going forward. If, instead the
company distributes $2 per share at the 5th year, the growth rate
of dividends will be 6% per year. As an investor of CHERCRO, which
policy would you support if the market rate is 12%?
(Hint: the value of a share is the expected present value of the
entire future dividend stream)
Policy 1
Price at end of year 4 = D5/(rs-g)
= 3 /(.12-.02)
= 3/.10
= $ 30 per share
Price Today =PVF12%,4* Price at end of year 4
= .63552 * 30
= $ 19.07 PER SHARE
Policy 2 :
Price at end of year 4 = D5/(rs-g)
= 2 /(.12-.06)
= 3/.06
= $ 50 per share
Price Today =PVF12%,4* Price at end of year 4
= .63552 * 50
= $ 31.78 PER SHARE
Policy 2 should be adopted since market price per share is higher under policy 2.