Question

M.cq answer needed with workings immediately

Ray Inc. company is not expected to pay any dividends for three years while it attempts to restructure its business. They anticipate paying $1.50 in year four and thereafter growing at a rate of 6%. What should we pay for the stock if we demand a 15% rate of return?

$8.77

$10.96

$14.24

$17.79

$9.50

Answer 1

	Given
	Expected dividend in year 4=	$1.50
	Perpetual Growth =	6%
	Equity cost of capital=	15%
	Solution
Step1	Present value of dividend=	1.50/(1.15^4)
	=	0.86
	Calculation of Horizon value
	As per Gordon Model=	Expected dividend/(Cost of capital-growth rate)
	Expected dividend at the end of 4th year=	(1.50*1.06)= 1.59
	=
	Value of firm at the end of 4th year=	1.59/(0.15-0.06)	= $17.67
Step 2	Present horizon value =	(17.67)/(1.15^4)
	=	10.10
Present value of stock = step1+step2 i.e. 10.10+0.86= $ 10.96
Hence the correct option is option b i.e. we should pay $10.96.