Question

ABC private limited as given the dividend of $5 last year and has promised to increase the dividend by 8% each year for the next four years.

1. Find out the dividend of each of the next four years.
2. If the stocks are selling at $120 at the end of fourth year, find out the price of stock today, assuming expected return as 12%.
3. Write a detailed comment on what will happen to the today’s selling price of the stock if the expected return is increased from 12% to 16%.
4. If the stocks are selling at $90 today, find out the price of stock at the end of fourth year, assuming expected return as 12%.
5. Write a detailed comment on what will happen to the selling price of the stock at the end of fourth year if the expected return is decreased from 12% to 8%.

Answer 1

Part A:

Year	Cash Flow / Div	Formula	Calculation
1	$                     5.40	D0 ( 1 + g)	5 ( 1 + 0.08 )
2	$                     5.83	D1 ( 1 + g)	5.4 * ( 1 + 0.08 )
3	$                     6.30	D2 ( 1 + g)	5.83 * ( 1 + 0.08 )
4	$                6.8024	D3 ( 1 + g)	6.3 * ( 1 + 0.08 )

Part B:

Price of stcok is PV of CFs from it.

Year	Particulars	Cash Flow	PVF @12 %	Disc CF
1	D1	$      5.40	0.8929	$              4.82
2	D2	$      5.83	0.7972	$              4.65
3	D3	$      6.30	0.7118	$              4.48
4	D4	$      6.80	0.6355	$              4.32
4	P4	$ 120.00	0.6355	$           76.26
Price				$           94.54

Part C:

As the discount rate is oncreased, Price of STock will decrease.

Year	Particulars	Cash Flow	PVF @16 %	Disc CF
1	D1	$      5.40	0.8621	$              4.66
2	D2	$      5.83	0.7432	$              4.33
3	D3	$      6.30	0.6407	$              4.04
4	D4	$      6.80	0.5523	$              3.76
4	P4	$ 120.00	0.5523	$           66.27
Price				$           83.06

Part D:

Price of STock = PV of CFs from it. As P4 is drecreased, Price today will also decrease.

Year	Particulars	Cash Flow	PVF @12 %	Disc CF
1	D1	$      5.40	0.8929	$              4.82
2	D2	$      5.83	0.7972	$              4.65
3	D3	$      6.30	0.7118	$              4.48
4	D4	$      6.80	0.6355	$              4.32
4	P4	$   90.00	0.6355	$           57.20
Price				$           75.47

Part E:

IF we want the same Price today, We need to have lesser amount at year4 ( P4 ) when the discount rate is shifted from 12% to 8%.

Thus Price at the end of Year4 will decrease.