Valero paid a dividend of $1.28 this morning. as per the management discussion and the financial...

Valero paid a dividend of $1.28 this morning. as per the management discussion and the financial position of the company, dividend next year is expected to be higher by 2%. after that you expect the dividend to grow at a flat of 1.0% forever. if the required rate of return is 7.8%, what should be the post-dividend stock price?

A. 19.20

B. 18.82

C. 22.07

D. 19.40

Expert Solution

Calculation of Post dividend stock price
Year	Dividend	Present value factor @ 7.8%	Present Value
1	$1.31	0.92764	$1.21
PV of future dividends (see working)	$19.39	0.92764	$17.99
Post dividend stock price'			$19.20

Post dividend stock price		$19.20

The answer is Option A.

Working - 1
1st Year dividend = Dividend paid in the morning x (1 + dividend growth rate in Year 1) = $1.28 x (1+0.02) = $1.31

Working - 2
Using dividend discount model, we can calculate the present value (at the end of 5th year) of future dividends
growing to perpetuity @ 1% per year from 1st Year onwards
Present value of future dividend at the end of 1st Year = D2/(r -g)
D2 = dividend payable in 2nd year = Dividend in 1st Year x (1+Growth Rate) = $1.31 * (1+0.01) = $1.32
r = required rate of return = 7.8%
g = dividend growth rate = 1%
Present value of future dividends at the end of 1st Year = 1.32 / (0.078 - 0.01) = $19.39

jeff jeffy answered 1 year ago

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