Question

In: Finance

ABC private limited as given the dividend of $5 last year and has promised to increase...

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%.

Solutions

Expert Solution

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.


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