Question

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Auto Transmissions is expected to pay annual dividends of $1.90 and $2.10 over the next two...

Auto Transmissions is expected to pay annual dividends of $1.90 and $2.10 over the next two years, respectively. After that, the company expects to pay a constant dividend of $2.30 per share. What is the value of this stock at a required return of 15%?

Select one:

a. $13.67

b. $15.60

c. $14.21

d. $15.08

e. $14.83

Expert Solution

Step-1, Calculation of Dividend per share for the next 3 years

Dividend in Year 1 (D1) = $1.90 per share

Dividend in Year 2 (D2) = $2.10 per share

Dividend in Year 3 (D3) = $2.30 per share

Step-2, Calculation of Stock Price for the Year 2 (P2)

Stock Price for the Year 2 = D3 / Ke

= $2.30 / 0.15

= $15.33 per share

Step-3, Current price of the stock (P0)

As per Dividend Discount Model, the Value of the Stock is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 2

Year	Cash flow ($)	Present Value Factor (PVF) at 15.00%	Present Value of cash flows ($) [Cash flows x PVF]

1	1.90	0.86957	1.65
2	2.10	0.75614	1.59
2	15.33	0.75614	11.59

TOTAL			14.83

“Hence, the value of this stock will be e. $14.83”

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 year

jeff jeffy answered 1 year ago

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