Question

The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 15 percent a year for the next 4 years and then decreasing the growth rate to 5 percent per year. The company just paid its annual dividend in the amount of $2.20 per share. What is the current value of one share of this stock if the required rate of return is 7.70 percent?

Answer 1

Given that, the dividend amount just paid=$2.2
The company is planning on increasing its annual dividend by 15 percent a year for the next 4 years. So, the dividend payments in the coming 4 years will be:
Year 1:$2.2*(1+15%)=$2.53

Year 2:$2.53*(1+15%)=$2.9095

Year 3:$2.9095*(1+15%)=$3.345925

Year 4:$3.345925*(1+15%)=$3.84781375

Terminal value=(Dividend in year 4)*(1+Growth rate)/(Required rate of return - Growth rate)

The growth rate will decrease to 5 percent per year after year 4.
Given that the required rate of return is 7.70 percent.
Terminal value=$3.84781375*(1+5%)/(7.7%-5%)
=$3.84781375*(1.05)/(2.7%)
=$3.84781375*38.88888889
=$149.6372014

Present value of the stock=(Dividend in year 1)/(1+required return)^1+(Dividend in year 2)/(1+required return)^2+(Dividend in year 3)/(1+required return)^3+(Dividend in year 4)/(1+required return)^4+Terminal value/(1+required return)^4
=$2.53/(1+7.7%)^1+$2.9095/(1+7.7%)^2+$3.345925/(1+7.7%)^3+$3.84781375/(1+7.7%)^4+$149.6372014/(1+7.7%)^4
=$2.53/(1.077)^1+$2.9095/(1.077)^2+$3.345925/(1.077)^3+$3.84781375/(1.077)^4+$149.6372014/(1.077)^4
=$2.53/1.077+$2.9095/1.159929+$3.345925/1.249243533+$3.84781375/1.345435285+$149.6372014/1.345435285
=$2.34911792+$2.508343183+$2.678360873+$2.859902511+$111.218431
=$121.6141555