Question

Stag Company will pay dividends of $4.75, $5.25, $5.75, and $7 for the next four years. Thereafter, the company expects its growth rate to be at a constant rate of 7 percent. If the required rate of return is 15 percent, what should the value of the share be immediately after the company makes the second dividend payment ($5.25)? (round to the nearest cent)

Select one:

a. $69.42

b. $75.08

c. $87.50

d. $81.09

Answer 1

Answer - Option D ($81.09)

Calculation :-

Step 1 - Calculate Terminal Value :-

Terminal Value = Dividend before becoming constant (1 + constant growth rate) / (required rate of return - constant growth rate)

Terminal Value = $7 (1.07) / (0.15 - 0.07)

Terminal Value = $93.635

Step 2 - Calcualte the Present Value of Terminal Value arrived :-

Present Value of Terminal Value = (Terminal Value / 1 + required rate of return)N

Whereas N refers to number of years ahead from the Present year (2 years in this case as terminal Value arrived 2 years ahead)

Therefore;

Present Value of Terminal Value = ($93.635 / 1.15)2

Present Value of Terminal Value = $70.794

Step 3 - Calcualte the Present Value of remaining dividends:-

Present Value of remaining dividends = (Dividend Left to be paid / 1 + required rate of return)N

Present Value of remaining dividends = (5.75 / 1.15) + (7 / 1.15)2

Present Value of remaining dividends = $5 + $5.293

Present Value of remaining dividends = $10.293

Step 4 - ADD Present Value of Terminal Value & Present Value of remaining dividends to get value of the share:-

Value of the share = Present Value of Terminal Value + Present Value of remaining dividends

Value of the share = $70.794 + $10.293

Value of the share = $81.09