NU YU announced today that it will begin paying annual dividends. The first divi
ID: 2759891 • Letter: N
Question
NU YU announced today that it will begin paying annual dividends. The first dividend will be paid next year in the amount of $0.47 a share. The following dividends will be $0.52, $0.67, and $0.97 a share annually for the following three years, respectively. After that, dividends are projected to increase by 3.3 percent per year. How much are you willing to pay today to buy one share of this stock if your desired rate of return is 14 percent?
NU YU announced today that it will begin paying annual dividends. The first dividend will be paid next year in the amount of $0.47 a share. The following dividends will be $0.52, $0.67, and $0.97 a share annually for the following three years, respectively. After that, dividends are projected to increase by 3.3 percent per year. How much are you willing to pay today to buy one share of this stock if your desired rate of return is 14 percent?
Explanation / Answer
Solution:
Current Market Price of NUYU stock is the sum of following:
1) Present Value of dividend paid during 1 to 4 years
2) Present Value of market price of stock at the end of 4th year at constant growth rate 3.3% p.a. at required rate of return 14%
Hence, Present Value of dividend paid (1-4 Years)
Year
Dividend
PV factor @ 14%
Present Value
1
$0.47
0.877
$0.41
2
$0.52
0.769
$0.40
3
$0.67
0.675
$0.45
4
$0.97
0.592
$0.57
$1.84
Present Value of Market Price of Stock at year end 4 = D5 / Required Rate of Return – Growth Rate x 0.592
= [ ($0.97 x 1.033) / 0.14 – 0.033 ] x 0.592 = [ $1.00201 / 0.107 ] x 0.592 = $9.3646 x 0.592 = $5.544
Hence we will get following equation:
Current Market Price = PV of Dividend Paid (1-4 Years) + PV of market price at year end 4
Current Market Price = $1.84 + $5.544 = $7.384
Year
Dividend
PV factor @ 14%
Present Value
1
$0.47
0.877
$0.41
2
$0.52
0.769
$0.40
3
$0.67
0.675
$0.45
4
$0.97
0.592
$0.57
$1.84
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