Question

Problem 6-16 Nonconstant Dividends Morning Dew, Inc., has an odd dividend policy. The company has just paid a dividend of $4 per share and has announced that it will increase the dividend by $6 per share for each of the next five years, and then never pay another dividend. If you require a return of 10 percent on the company's stock, how much will you pay for a share today? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) Current share price $

Answer 1

We can arrive at the current price by using the dividend growth model formula.

P = D1 / ( k – g )

P = fair value price per share of the equity

D = expected dividend per share one year from the present time

g = expected dividend growth rate

k = required rate of return

g= ($6-$4)/$4 = 50%

P = $4/(10%-50%) = $10.