Question

Martin Office Supplies paid a $3 dividend last year. The dividend is expected to grow at a constant rate of 6 percent over the next four years. The required rate of return is 12 percent (this will also serve as the discount rate in this problem). Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Compute the anticipated value of the dividends for the next four years.

b. Calculate the present value of each of the anticipated dividends at a discount rate of 12 percent.

c. Compute the price of the stock at the end of the fourth year (P4).

d. Calculate the present value of the year 4 stock price at a discount rate of 12 percent.

e. Compute the current value of the stock.

f. Use the formula given below to show that it will provide approximately the same answer as part e.

g. If current EPS were equal to $6.95 and the P/E ratio is 10% higher than the industry average of 7, what would the stock price be?

h. By what dollar amount is the stock price in part g different from the stock price in part f?

i. With regard to the stock price in part f, indicate which direction it would move if:

(1) D1 increases :

(2) K_e increases :

(3) g increases :

Answer 1

Answer: A: Value of the Dividend for the next 4 years

Formula for this, Last year Dividend *( 1 + Expected increase rate)

1st year = 3(1+0.06) = 43.18

2nd year = 3.18 * (1+ 0.06) =$3.37

3rd year = 3.37 *(1 + 0.06) =$3.57

4th Year = 3.57*(1+0.06) = $3.79

Answer B: Present value formula : Cash Flow/ ( 1+ Discount rate ) ^ ( No of year)

Year	1	2	3	4
Cash Flow	3.18	3.37	3.57	3.79
Present value	2.839286	2.687181	2.543225	2.406981
Sum	10.47667

Answer 3 : Price of the Stock at the end of the 4th year :

P 4 = D5/(Ke - g)

D5 = 3.79 * (1.06) = 4.01

Ke = 0.12

g = 0.06

P4 = 4.01/(0.12-0.06) = $66.91

Answer 4: Present value of the stock at a discount rate of 12%

Using the same formula again

Present value = Value /(1 + Discount rate ) ^ ( no of year)

Present value = 66.91/(1+0.12)^4

Present value = $42.52

Answer 5:Current value of the stock :

PV of Dividends( from part b) = $10.47

PV of P4(stock value at 4) = $42.52

Current value = $53

Answer 6: Using the equation to calculate the current value P0 = D1/(ke-g)

P0 = 3.18/(0.12-0.06)

P0 = 53

In one question we are allowed to answer at max 4 questions part. I have answered 6 please put the rest of the question separately.