Elvis Inc. common stock is expected to pay their first dividend of $2 at the end...

Elvis Inc. common stock is expected to pay their first dividend of $2 at the end of two years from today. Once the firm starts paying dividends, analysts expect the dividends to grow at a supernormal rate of 8% for the next year, and then attain a constant growth of 2% forever thereafter. The required rate of return on the stock is 7.5%.

a) What is the value of Elvis Inc.'s stock today?
b) In addition to the regular dividend stream, Elvis Inc. has announced that they will distribute a special dividend of $1.35 per share at the end of each of the first three years. What will be the value of the stock today?

Expert Solution

Ans a
	Year	1	2	3	Total
	Dividend	0	2	2.16
				(2*1.08)
	Discounting factor for 7.5%	0.9302	0.8653	0.8050
Step1	Present value at 7.5%	-	1.73	1.74	3.47

Step2	Horizon value at the end of 3rd year as per gordon model=	Expected dividend in Year4/(Ke-g)
		=	40	(2.20/(0.075-0.02))
	Present value of horizon value=	32.20	(40/(1.075^3))

	Expected dividend in Year4=		2.20	(2.16*1.02)

Step3=Step1+step2	Value of stock today=step 1 +step2
		35.67	(3.47+32.2)
	Note: Ke = cost of capital and g=growth.

Ans b
	Year	1	2	3	Total
	Dividend	0	2	2.16
	Special dividend	1.35	1.35	1.35
Step1	Total dividend	1.35	3.35	3.51
				(2*1.08)
	Discounting factor for 7.5%	0.9302	0.8653	0.8050
	Present value at 7.5%	1.26	2.90	2.83	6.98

Step2	Horizon value at the end of 3rd year as per gordon model=	Expected dividend in Year4/(Ke-g)
		=	40	(2.20/(0.075-0.02))
	Present value of horizon value=	32.20	(40/(1.075^3))

	Expected dividend in Year4=		2.20	(2.16*1.02)

Step3=Step1+step2	Value of stock today=step 1 +step2
		39.18	(6.98+32.2)
	Note: Ke = cost of capital and g=growth.

jeff jeffy answered 1 year ago

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