Question

The dividend for Should I, Inc., is currently $1.45 per share. It is expected to grow at 16 percent next year and then decline linearly to a 4 percent perpetual rate in four years. If you require a 11 percent return on the stock, what is the most you would pay per share? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.)

Answer 1

The price is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + 1 / (1 + required rate of return)³ [ ( Dividend in year 3 (1 + growth rate) / ( required rate of return - growth rate ) ]

= ( $ 1.45 x 1.16 ) / 1.11 + ( $ 1.45 x 1.16 x 1.12 ) / 1.11²+ ( $ 1.45 x 1.16 x 1.12 x 1.08) / 1.11³ + 1 / 1.11³ [ ($ 1.45 x 1.16 x 1.12 x 1.08 x 1.04 ) / ( 0.11 - 0.04) ]

= $ 1.682 / 1.11 + $ 1.88384 / 1.11² + $ 2.0345472 / 1.11³ + $ 30.2275584 / 1.11³

= $ 26.63 Approximately

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