Yang Corp. is growing quickly. Dividends are expected to grow at a rate of 30 pe
ID: 2762127 • Letter: Y
Question
Yang Corp. is growing quickly. Dividends are expected to grow at a rate of 30 percent for the next three years, with the growth rate falling off to a constant 7 percent thereafter.
If the required return is 13 percent and the company just paid a $2.60 dividend, what is the current share price? (Hint: Calculate the first four dividends.) (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
Yang Corp. is growing quickly. Dividends are expected to grow at a rate of 30 percent for the next three years, with the growth rate falling off to a constant 7 percent thereafter.
Explanation / Answer
Solution:
Current Share Price of Yang Corp is the sum of following:
(i) Present Value of Dividend payment from 1-3 year and
(ii) Present Value of Share Price at the end of year 3 as per dividend growth model at constant growth rate 7% p.a. and at required return 13%
Present Value of Dividend Payment (1 – 3 Years)
Year
Dividend
PV factor @ 13%
Present Value
1
$2.60 x (1+0.30) = $3.38
0.885
$2.9913
2
$3.38 x 1.3 = $4.394
0.783
$3.441
3
$4.394 x 1.3 = $5.7122
0.693
$3.959
Total
$10.39 or $10.40
Share Price at the end of year 3 (as per dividend growth model) = D4 / Required Return – Growth Rate
= ($5.7122 x 1.07) / (0.13 – 0.07) = $6.112 / 0.06 = $101.87
Present Value of Share Price at the end of year 3 = $101.87 x 0.693 = $70.59
Current Price of Share = $10.40 + $70.59 = $80.99 or $81
Year
Dividend
PV factor @ 13%
Present Value
1
$2.60 x (1+0.30) = $3.38
0.885
$2.9913
2
$3.38 x 1.3 = $4.394
0.783
$3.441
3
$4.394 x 1.3 = $5.7122
0.693
$3.959
Total
$10.39 or $10.40
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