Question

3. MBV is a cruise line which announced that dividends are expected to grow by 3.5 percent
annually, having paid a recent dividend of $1.20 per share last month. If you require a 15
percent rate of return, how much are you willing to pay to purchase one share of this stock
today?

4. What would you pay for a share of common stock of Pizza Hut where the last dividend was $17
and dividend is expected to increase by 1.6 percent annually, assuming a cost of equity of 15
percent?

Answer 1

2.The question using the dividend discount model.

Recent dividend= $1.20

Growth rate= 3.5%

Required rate of return= 15%

Price of the stock today= D1/(r-g)

where:

D1=next dividend payment

r=interest rate

g=firm’s expected growth rate

Price of the stock today= $1.20*(1+ 0.035)/ 0.15- 0.035

                                             = $1.2420/ 0.1150 = $10.80.

3.The question using the dividend discount model.

Recent dividend= $17

Growth rate= 1.6%

Cost of equity= 15%

Price of the stock today= D1/(r-g)

where:

D1=next dividend payment

r=interest rate

g=firm’s expected growth rate

Price of the stock today= 17*(1+ 0.016)/ 0.15- 0.016

                                             = 17.2720/ 0.1340 = $128.90.