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TCU Corp. pays a current dividend of $5 per year, which is expected to grow by...

TCU Corp. pays a current dividend of $5 per year, which is expected to grow by 10% the next two years, then by 6% for the following two years, and from year 5 and on maintain a 3% constant growth. The discount rate is 8%. Calculate the current price of one share of TCU Corp.

Expert Solution

Step-1, Dividend for the next 4 years

Dividend in Year 0 (D0) = $5.00

Dividend in Year 1 (D1) = $5.5000 [$5.00 x 110%]

Dividend in Year 2 (D2) = $6.0500 [$5.5000 x 110%]

Dividend in Year 3 (D3) = $6.4130 [$6.05 x 106%]

Dividend in Year 4 (D4) = $6.7978 [$6.4130 x 106%]

Step-2, Share Price in Year 4

Dividend in Year 4(D4) = $6.7978

Dividend Growth Rate after Year 4 (g) = 3.00% per year

Required Rate of Return (Ke) = 8.00%

Share Price in Year 4 (P4) = D4(1 + g) / (Ke – g)

= $6.7978(1 + 0.03) / (0.08 – 0.03)

= $7.0017 / 0.05

= $140.03

Step-3, The current price of one share of TCU Corp.

As per Dividend Discount Model, Current Stock Price the aggregate of the Present Value of the future dividend payments and the present value the share price in year 4

Year	Cash flow	Present Value Factor (PVF) at 8.0%	Present Value of cash flows [Cash flows x PVF]

1	5.5000	0.92593	5.09
2	6.0500	0.85734	5.19
3	6.4130	0.79383	5.09
4	6.7978	0.73503	5.00
4	140.03	0.73503	102.93

TOTAL			123.30

Hence, the current price of one share of TCU Corp will be $123.30

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.

jeff jeffy answered 1 year ago

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