Question

A company recently paid a dividend (D) of $2.25. It expects to pay a dividend of $2.48 next year. The dividend should grow rapidly from there with growth in year 2 of 40%, growth in year 3 of 35%, growth in year 4 of 18%. The stock will then turn into a constant growth stock with a growth rate of 9% for all years after year 4. Stockholders' required return is 16.5%. Calculate p^o and show all of your work to receive full credit for all steps including: the future expected dividend calculations, the discounting of those dividends back to the present value, the horizon/terminal value calculation, the discounting of the terminal value back to the present value, and the final sum of all the present values to arrive at po.

Answer 1

1 D1 2.13 Present Value after discounting at Required Dividend Growth Required Rate Rate DO $ 2.25 $ 2.48 16.50% $ 2 D2 $ 3.47 40% 16.50% $ 2.56 3 D3 $ 4.69 35% 16.50% $ 2.96 4 D4 $ 5.53 18% 16.50% $ 3.00 $ 6.03 9% 16.50% $ 2.81 5 Terminal Value at D5 $ 87.62 16.50% $ 40.83 (this is price of stock at the end of year 5) SUM OF ALL FUTURE VALUE DISCOUNTED @ 16.5% TO PRESENT 54.29 OR CURRENT VALUE OF STOCK AT DO 5 05

Calculation of Terminal Value at the end of year 5 is calculated as =

Dividend at year 5 x Growth Rate / ( Required Rate of Return - Growth Rate)

= 6.03 x 1.09 / (0.165-0.00)

=87.62

Now this is the price of the stock at the end of year 5 (note that this is the price after dividend of year 5 has been given).

Now, also note that they will also receive dividend at year 1, year 2, year 3, year 4 and year 5 as well apart from the terminal value

The dividends for year 2, 3, 4 and 5 are simply as per growth rate given in the question.

Now, we have to discount all these values to present value to arrive at the stock's present value (P^0)

Now, refer to column J wherein all dividends and terminal value are discounted at 16.5% to arrive at present value of the stock and take the sum of all the values.

Please post your comment if you are not clear at any point.

Thanks