12. Twenty years ago, Elle Inc. began manufacturing and selling coin-operated ar

Question

12. Twenty years ago, Elle Inc. began manufacturing and selling coin-operated arcade games. Dividends are currently $5.50 per share, having grown at a 8 percent compound annual rate over the past 12 years. That growth rate is expected to be maintained for the next 2 years, after which dividends are expected to grow at half that rate for 2 years. Beyond that time, Elle's dividends are expected to grow at 2 percent per year. What is the current value of a share of Elle common stock if your required rate of return is 12%?

Explanation / Answer

Current dividend price = 5.50

Using Gordon Growth Model
Present value of all the dividends (year 5 onwards) at the end of year 4 = Dividend price in year 5/(Required rate- growth rate)
= 7.08/(0.12-0.02)
=70.8

We have following cash flows
CF1 = 5.94
CF2 = 6.42
CF3 = 6.67
CF4 = 6.94+ 70.8 = 77.74
Required rate = 12%

Feeding these values in financial calculator and solving for NPV, we get
NPV = 64.57
Hence the current value of a share is $64.57

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