Question

Solve the problem. Show your work and equations! Please do not show screenshots of Excel as your work shown.

5. The company stock increases dividend by 5% each year and the expected dividend in 5 years is $5. Analysts expect that investors would require 10% return on this stock. The company will cease paying dividend after the 5th dividend (dividend in year 5). That is, the firm will pay 5 dividends annually and from year 6 shareholders will not receive any further dividend. Find the share price today. Use annual compounding.

Answer 1

D₅ = $5

D₁ = 5/(1.05)⁴ = $4.11

So,

This is a problem of Growing Annuity,

So,

Stock Price = Present Value

Present Value = P/(r - g)[1 - ((1 + g)/(1 + r))ⁿ]

Present Value = 4.11/(0.10 - 0.05)[1 - (1.05/1.10)⁵]

Present Value = $17.06

So,

Stock Price = $17.06

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