Your broker offers to sell you some shares of Bahnsen & Co. common stock that pa

Question

Your broker offers to sell you some shares of Bahnsen & Co. common stock that paid a dividend of $4.00 yesterday. Bahnsen's dividend is expected to grow at 5% per year for the next 3 years. If you buy the stock, you plan to hold it for 3 years and then sell it. The appropriate discount rate is 11%.

A. ) Find the expected dividend for each of the next 3 years; that is, calculate D1, D2 and D3. Note that D0 = $4.00. Round your answer to the nearest cent.

d1= ? d2=? d3=?

B.) Given that the first dividend payment will occur 1 year from now, find the present value of the dividend stream; that is, calculate the PVs of D1, D2, and D3 and then sum these PVs. Round your answer to the nearest cent.

C.) You expect the price of the stock 3 years from now to be $81.03; that is, you expect P3 to equal $81.03. Discounted at a 11% rate, what is the present value of this expected future stock price? In other words, calculate the PV of $81.03. Round your answer to the nearest cent.

D.) If you plan to buy the stock, hold it for 3 years, and then sell it for $81.03, what is the most you should pay for it today? Round your answer to the nearest cent.

Explanation / Answer

A.)

B.) Present Value of Dividend Stream

C.) Present Value of expected future stock price

Present Value = Future Value /(1+r)n

= $81.03 / (1.11)3

= $198.01

D.) Price to be paid = $70

Expected Dividend = Dividend + Growth Rate D0 = 4 D1 = 4 + 5% = 4.2 D2 = 4.2 + 5% = 4.41 D3 = 4.41 + 5% = 4.63

B.) Present Value of Dividend Stream

Year Dividend PV Factor Present Value 1 4.2 0.9009 3.78378 2 4.41 0.8116 3.579156 3 4.63 0.7312 3.385456 Total Present Value 10.748392

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