Question

3.Bloomberg Co. announced today that its next annual dividend w山 be $2.60 per share. After that dividend is paid, the company expects to encounter some financial difficulties and is going to suspend dividends for 5 years. Following the suspension period, the company expects to pay a constant annual dividend of $1.30 per share. What is the current value of this stock if the required return is 10 percent?

A.$2.36

B.$3.55

C.$7.34

D.$8.07

E.$9.7

Answer 1

Price of a stock is the present value of all future cash flows receivable from the stock discounted at required rate of return

Future cash flows are annual dividends and terminal value of dividends whose growth rate will be constant

Growth rate = 0 after year 6 years ( from 6^th year and onwards as fixed dividend will be paid )

D1 = Expected dividend next year = $2.60

D2 = Expected divided in year 2 = $0

D3 = D4 = D5 = D6 = $0

After this, constant dividend of $1.30 will be paid

So, we need to calculate the terminal value of all future dividends receivable at the end of year 6 at 0% growth rate ( as dividend is fixed )

= D7 / ( Re – G)

= $1.30 / ( 0.10 – 0.00 )

= $ 13

Present value factor

= 1 / ( 1 + Re ) ^ Number of years

So, PV Factor for year 2 will be

= 1 / ( 1.10 ^ 2)

= 1 / 1.21

= 0. 0.826446

The following table shows the calculations

Calculations	A	B	C = A x B
Year	Cash Flow	PV Factor	Present Value
1	2.6	0.909091	2.36
2	0	0.826446	0.00
3	0	0.751315	0.00
4	0	0.683013	0.00
5	0	0.620921	0.00
6	0	0.564474	0.00
6	13	0.564474	7.34
		Price	9.70

So, as per above calculations, the price is $9.7 and so option E is the correct option