Question

Delay Corp. does not currently pay any dividends. The CFO declared that the firm will pay its first annual dividend of $10 per share in 3 years. From there, the firm will grow its annual dividends at 2% per year. If the fair cost of equity for Delay Corp. is 12% per year, what is the fair share price?

Answer 1

This question requires application of constant growth dividend discount model and basic time value of money function,

According to constant growth dividend discount model,

Div Po r-g Po= Price of Stock Div = Estimat ed Dividends for Next Period rRequired Rate of Return g Growth Rate

$P_2 = \frac{Div_3}{r - g}$

$P_2 = \frac{10}{0.12 - 0.02}$

$P_2 = 100$

Now, based on time value of money function,

FV = PV * (1 + r)ⁿ

$100 = PV * (1 + 12%)²

$100 = PV * 1.2544

PV = $79.72