In: Accounting
Lohn Corporation is expected to pay the following dividends over the next four years: $13, $9, $5, and $2. Afterward, the company pledges to maintain a constant 6 percent growth rate in dividends forever. |
If the required return on the stock is 14 percent, what is the current share price? |
Multiple Choice
$37.89
$46.65
$39.74
$38.58
$36.65
CALCULATION OF MARKET VALUE OF THE STOCK AT THE END OF 4TH YEAR | |||||
Formula | P4 = D5 / Ke - g | ||||
Ke = Cost of Equity = Expected return = 14% = 0.14 | |||||
g = Growth rate = 6% = 0.06 | |||||
P4 = price of the stock at the end of 4th year | |||||
D5 = Dividend at the end of 5th year = $ 2 X 1.06 = $ 2.12 | |||||
P4 = D5 / Ke - g | |||||
P4 = $ 2.12 / 0.14 - 0.06 | |||||
P4 = $ 2.12 / 0.08 | |||||
P4 = $ 26.50 | |||||
CALCULATION OF CURRENT SHARE PRICE | |||||
Year | Dividend | PVF of $ @ 14% | Present Value | ||
1 | $ 13.00 | 0.87719 | $ 11.40 | ||
2 | $ 9.00 | 0.76947 | $ 6.93 | ||
3 | $ 5.00 | 0.67497 | $ 3.37 | ||
4 | $ 2.00 | 0.59208 | $ 1.18 | ||
Stock Value P4 | 4 | $ 26.50 | 0.59208 | $ 15.69 | |
Total | $ 38.58 | ||||
Answer = Option 4 = $ 38.58 | |||||