Corp. forecasts its dividends to be $2.25 per share next year, $2.75 per share in two...

Corp. forecasts its dividends to be $2.25 per share next year, $2.75 per share in two years, and $3.60 per share in three years. After the third year, dividends are anticipated to grow at a constant sustainable rate of 5.0% per year. If cost of capital is 16.0% and its applicable rate is 35.0%, what is the estimated share price for the company's common equity? YOU MUST USE AT LEAST 4 DECIMIL PLACES IN ALL CALCULATIONS AND SHOW ALL WORK TO RECEIVE CREDIT.

Solutions

Expert Solution

Step-1, Dividend for the next 3 years

Dividend per share in Year 1 (D1) = $2.25 per share

Dividend per share in Year 2 (D2) = $2.75 per share

Dividend per share in Year 3 (D3) = $3.60 per share

Step-2, Share Price in Year 3

Dividend Growth Rate after Year 3 (g) = 5.00% per year

Required Rate of Return (Ke) = 16.00%

Therefore, the Share Price in Year 3 (P3) = D3(1 + g) / (Ke – g)

= $3.60(1 + 0.05) / (0.16 – 0.05)

= $3.78 / 0.11

= $34.36 per share

Step-3, The estimated share price for the company's common equity

As per Dividend Discount Model, the share price for the company's common equity is the Present Value of the future dividend payments and the present value the share price in year 3

Year	Cash flow ($)	Present Value factor at 16.00%	Present Value of cash flows ($)

1	2.25	0.8621	1.94
2	2.75	0.7432	2.04
3	3.60	0.6407	2.31
3	34.36	0.6407	22.02

TOTAL			28.31

“Therefore, the estimated share price for the company's common equity will be $28.31 per share”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.

jeff jeffy answered 8 months ago

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