Suppose a dividend of $1.25 was paid. The stock has a required rate of return of

Question

Suppose a dividend of $1.25 was paid. The stock has a required rate of return of 11.2% and investors expect the dividend to grow at a constant rate of 10%. Complete parts (a) through (e) below.

a)      Compute D0, D1, D2, D3 and D7.

b)      Compute the present value of the dividends for t = 3 years.

c)       Compute the current market price.

d)      Assume that the constant growth rate is actually 0%. What is the current market price?

Suppose a dividend of $1.25 was paid. The stock has a required rate of return of 11.2% and investors expect the dividend to grow at a constant rate of 10%. Complete parts (a) through (e) below. Compute D0, D1, D2, D3 and D7. Compute the present value of the dividends for t = 3 years. Compute the current market price. Assume that the constant growth rate is actually 0%. What is the current market price? Describe the behavior of the present value of each future dividend (i.e. the behavior as t increases).

Explanation / Answer

(a)

D0= $1.25

D1= 1.25x1.1= $ 1.375

D2= 1.25x1.1^2= $ 1.5125

D3= 1.25x1.1^3= $ 1.664

D7= 1.25x1.1^7= $ 2.436

(b) PV of the dividends for t = 3 years= (1.375/1.112)+(1.5125/1.112^2) + (1.664/1.112^3)= $3.67

(c) current market price= D1/(Ke-g)

= 1.375/(.112-.1)= $114.58

(d) current market price= 1.25/.112= $11.161

As T increases the present value of each future dividend also increases.

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