Question

Question 21 (1 point) MMC expects to pay its first dividend at the end of the year. The first dividend is expected to be $0.25 and the second $1.15. Then, dividends are expected to grow at 3% thereafter. Given a required return of 10%, what should the value of the stock be today? a) 10.81 Ob) 22.61 Oc) 23.73 d) 15.16 e) 47.19

Answer 1

d) $15.16

With nonconstant dividends, we find the price of the stock when the dividends level off at a constant growth rate, and then find the present value of the future stock price, plus the present value of all dividends during the nonconstant growth period. The stock begins constant growth after the second dividend is paid, so we can find the price of the stock at Year 2, when the constant dividend growth begins, as:

P₂ = D₂(1 + g) / (R – g)

P₂ = $1.15(1.03) / (.10 – .03)

P₂ = $16.92

The price of the stock today is the present value of the first two dividends, plus the present value of the Year 2 stock price. So, the price of the stock today will be:

P₀ = $0.25 / 1.10 + $1.15 / 1.10² + $16.92 / 1.10²

P₀ = $15.16