Question

Deferred Dividends Downloads for Cheap, Inc. has a new business that allows customers to download music and movies directly onto their IPhones or MP3 players in grocery stores. The downloaded items can be played on their TVs or computers at home. The firm is in the high growth phase and does not currently pay dividends. Managers are estimating that the firm will begin paying an annual dividend per share of $1.40 in four years and that dividends will then grow at 5% per year thereafter. What is the most you should be willing to pay for the stock today if the required return on the stock is 14%? Multiple Choice 0 $9.00 0 $11.16 0 $10.50 0 $9.64

Answer 1

As per information given Dividend is as follows

D1 =0, D2 =0, D3=0, D4 =1.4

Thereafter dividend grows at the rate of 5% (g).. Required return on stock is 14% (r)

Value of stock is = PV of all dividends

Since dividend till year 3 is nil, the present value of the Dividend till year 3 is nil.

PV of Dividend at the end of 4th year would be = D4/(1+r)^4 = 1.4/(1+14%)^4 =1.4 / 1.68896 = $0.8289.

From 5th year the dividend constantly grows at 5%. the value will be calculate as below

= (D4*(1+g)/(1+r)^4)/(r-g) = (1.4*(1+5%)/(1+14%)^4)/(14%-5%)

=(1.47/1.68896)/9%

=0/8703581/9%

=$9.6706

PV of all Dividends = PV of Dividend till year 3+ PV of dividend for year 4+PV of dividend year 5 onwards

=0+0.8289+9.6706

=$10.50