Question

Jedi Corp. 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%.

1. a) What is the value of Jedi’s stock today?

2. b) In addition to the regular dividend stream, Jedi Corp. 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?

Answer 1

First dividend is expected to be 2 years from now (D2) = $ 2

After first dividend, supernormal growth rate (g) = 8%

therafter constant growth rate (g2) = 2%

Required rate of return (ke) = 7.5%

Calculating the price of stock at the end of 2nd year:-

P2 = 2.0093 + 37.2634

P2 = $ 39.2727

Now calculating the value of Jedi's stock today:-

P0 = P2/(1+ke)^2

= 39.2727/(1+0.075)^2

= $ 33.98

So, the value of Stock today is $ 33.98

b). In addition to regular dividend, Jedi announced special dividend of $ 1.35 per share at the end of each of the first three years. Since, these dividend are special and won't be included in regular dividend to compute the value of Stock.

Rather the Present value of these diviidends will be added to the existing value of Stock.

Present Value of Special dividend

= $ 3.51

Hence, value of Stock today is= $ 33.98 + $ 3.51

= $ 37.49

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