Question

PLEASE ANSWER IN EXCEL FORMAT, WITH FORMULA USED. Thank you!!

8.Consider the following three stocks:

▪Stock A is expected to provide a dividend of $11.10 a share forever.

▪Stock B is expected to pay a dividend of $6.10 next year. Thereafter, dividend growth is expected to be 5.00% a year forever.

▪Stock C is expected to pay a dividend of $4.90 next year. Thereafter, dividend growth is expected to be 21.00% a year for five years (i.e., years 2 through 6) and zero thereafter.

If the required rate of return for each stock is 11.00%, what is the stock price for each of the stocks?

Answer 1

For stock A,

Annual dividend D = 11.1

required return r = 11%

So, stock price using perpetuity is

Stock price P0 = D/r = 11.1/0.11 = $100.91

For Stock B,

Expected next year dividend D1 = $6.1

Growth rate g = 5%

so, price of the stock using constant growth model is

stock price P0 = D1/(r-g) = 6.1/(0.11-0.05) = $101.67

For Stock C,

Expected next year dividend D1 = $4.9

expected growth rate for next 5 years = 21%

=> D2 = 4.9*1.21 = $5.9290

D3 = 5.929*1.21 = $7.1741

D4 = 7.1741*1.21 = 8.6806

D5 = 8.6806*1.21 = 10.5036

D6 = 10.5036*1.21 = 12.7093

thereafter dividend is constant

So, stock price at year 5 using constant dividend model is

P5 = D6/r = 12.7093/0.11 = $115.5394

So, stock price today = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 + D4/(1+r)^4 + D5/(1+r)^5 + P5/(1+r)^5

=> Stock price P0 = 4.9/1.11 + 5.929/1.11^2 + 7.1741/1.11^3 + 8.6806/1.11^4 + 10.5036/1.11^5 + 115.5394/1.11^5

=> P0 = 94.99

So, stock price is $94.99