A stock just paid annual dividends of $3.55 per share. The dividends are expected to grow at 20 per cent per year for 4 years, and then remain constant in perpetuity. If the investors' required return for the stock is 11.8 percent, what should be the price of the stock today?
As per dividend discount method, current share price is the present value of future dividends. | ||||||
Step-1:Present value of dividend of non-constant growth years | ||||||
Year | Dividend | Discount factor | Present value | |||
a | b | c=1.118^-a | d=b*c | |||
1 | $ 4.26 | 0.8945 | $ 3.81 | |||
2 | $ 5.11 | 0.8000 | $ 4.09 | |||
3 | $ 6.13 | 0.7156 | $ 4.39 | |||
4 | $ 7.36 | 0.6401 | $ 4.71 | |||
Total | $ 17.00 | |||||
Working; | ||||||
Dividend of Year : | ||||||
1 | = | $ 3.55 | * | 1.20 | = | $ 4.26 |
2 | = | $ 4.26 | * | 1.20 | = | $ 5.11 |
3 | = | $ 5.11 | * | 1.20 | = | $ 6.13 |
4 | = | $ 6.13 | * | 1.20 | = | $ 7.36 |
Step-2:Calculation of terminal value of dividend at the end of non-constant growth years | ||||||
Terminal value | = | (D5/Ke)*DF4 | Where, | |||
= | $ 39.93 | D5(Dividend of year 5) | = | $ 7.36 | ||
Ke (Required return) | = | 11.80% | ||||
DF4 (Discount factor of year 4) | = | 0.6401 | ||||
Step-3:Sum of present value of future dividends | ||||||
Sum of present value of future dividends | = | $ 17.00 | + | $ 39.93 | ||
= | $ 56.93 | |||||
So, Price of stock is | $ 56.93 |
A stock just paid annual dividends of $3.55 per share. The dividends are expected to grow...
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