Question

Analysts forecast that a company's dividends in 2019, 2020 and 2021 will be the same amount as the dividends paid in 2018 which was 0.05. After 2021 dividends will increase by 2% p.a. What is a fair price for a share in 2019? Required rate of return is 9%

Answer 1

Price of a stock is the present value of all future cash flows receivable from the stock discounted at required rate of return

Price of the stock at the end of 2021

= Dividend of 2021 x (1 + Growth) / (Required rate of return – Growth rate)

= $0.05 x 1.02 / (0.09 – 0.02)

= $0.7286

So, price of the stock today is calculated in the following table

Present value factor

= 1 / (1 + r) ^ n

Where,

r = Rate of return = 9% or 0.09

n = Years 1 to 3

So, PV Factor for year 2 will be

= 1 / (1.09^2)

= 1 / 1.1881

= 0.841680

Calculations	A	B	C = A x B
Years	Cash Flow	PV Factor	Present Value
1	0.05	0.917431	0.04587156
2	0.05	0.84168	0.042084
3	0.05	0.772183	0.038609174
3	0.7286	0.772183	0.562612884
		Price	0.6892

So, price today is $0.6892