Assume the average firm in your company\'s industry is expected to grow at a con

Question

Assume the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 6%. Companies is about as risky as average firm in their industry, but have successfully expect to receive earnings and dividend growth at 50% (D1=Do(1+g)=Do(1.50) this year and 25% the following year, after which growth should return to 4%. Last dividend paid (Do) was $2.5,what is the value per share of your firms stock? Assume the average firm in your company's industry is expected to grow at a constant rate of 4% and that its dividend yield is 6%. Companies is about as risky as average firm in their industry, but have successfully expect to receive earnings and dividend growth at 50% (D1=Do(1+g)=Do(1.50) this year and 25% the following year, after which growth should return to 4%. Last dividend paid (Do) was $2.5,what is the value per share of your firms stock?

Explanation / Answer

Do = $2.5

D1 = 1.5*2.5 = 3.75

D2 = 3.75*1.25 = 4.6875

D3 (with growth rate of 4%) = 4.6875*1.04 = 4.875

Now dividend yield = 6% i.e dividend/price = 6. We have the value of last dividend as 4.875. Substituting in the formula we get 6% = 4.875/price. Thus price = $81.25

expected rate of return = growth rate+dividend yield = 4%+6% = 10%.

Now, using the dividend discount model:

Discounted value of D0 = 2.5

Discounted value of D1 = 3.75/(1.1^1) = 3.41

Discounted value of D2 = 4.6875/(1.1^2) = 3.87

Dividend of D3 onwards is a perpetuity with a growth rate of 4%. Its present value = 4.875/(r-g) where r = 10% and g (or growth rate is 4%). Thus 4.875/.06 = 81.25

Adding all the discounted values = 2.5+3.41+3.87+81.25 = $91.03

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