Common stock value: Variable growth Lawrence Industries’ most recent annual divi

Question

Common stock value: Variable growth Lawrence Industries’ most recent annual
dividend was $1.80 per share (D0 = $1.80), and the firm’s required return is 11%.
Find the market value of Lawrence’s shares when:
a. Dividends are expected to grow at 8% annually for 3 years, followed by a 5%
constant annual growth rate in years 4 to infinity.
b. Dividends are expected to grow at 8% annually for 3 years, followed by a 0%
constant annual growth rate in years 4 to infinity.
c. Dividends are expected to grow at 8% annually for 3 years, followed by a 10%
constant annual growth rate in years 4 to infinity.

Explanation / Answer

Answer:

As per gorden growth model = terminal value in year 3 = P3 = D4/(r-g) = D3(1+g)/(r-g)

where D1 = Expected dividend of the next year, r = required rate of return, g = growth rate, D0 = Current year dividend

D1 = $1.8(1+0.08) = $1.944

D2 = $1.944(1+0.08)=$2.0995

D3 = $2.0995(1+0.08)= $2.267

D4 = $2.267(1+0.05) = $2.38

a. Market value of the share at the end of year 3rd year = P3 = $2.38/(0.11-0.05) = $39.67

Market value of the share today = D1/(1.11)1+D2/(1.11)2+ D3/(1.11)3+ P3/(1.11)3

= $1.944/1.11 + $2.0995/1.2321+ $2.267/1.3676 + $39.67/1.3676

= $1.751 + $1.704 + $1.658 + $29 = $34.113(Ans)

b. D4 = $2.267 (No growth)

P3 = $2.267/(0.11-0) = $20.61

Market value of the share today = D1/(1.11)1+D2/(1.11)2+ D3/(1.11)3+ P3/(1.11)3

= $1.944/1.11 + $2.0995/1.2321+ $2.267/1.3676 + $20.61/1.3676

= $1.751 + $1.704 + $1.658 + $15.07 = $20.18 (Ans)

C. D4 = $2.267(1+0.01) = $2.494

P3 = $2.494/(0.11-0.1) = $249.37

Market value of the share today = D1/(1.11)1+D2/(1.11)2+ D3/(1.11)3+ P3/(1.11)3

= $1.944/1.11 + $2.0995/1.2321+ $2.267/1.3676 + $249.37/1.3676

= $1.751 + $1.704 + $1.658 + $182.34 = $187.454 (Ans)

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.