Common Stock Value: Constant Growth Elk Country Telephone has paid the dividends
ID: 2772086 • Letter: C
Question
Common Stock Value: Constant Growth Elk Country Telephone has paid the dividends shown in the following table over the past 6 years.
2015
The firm's dividend per share next year is expected to be $3.02.
a. If you can earn 13% on similar-risk investments, what is th emost you would be willling to pay per share?
b. If you can earn only 10% on similar-risk investments, what is the most you would be willing to pay per share?
c. Compar and contrast your findings in parts a and b, and discuss the impact of changing risk on share value.
2015
$2.87 2014 2.76 2013 2.60 2012 2.46 2011 2.37 2010 2.25Explanation / Answer
a. We will use the dividend growth discount model to arrive at the value of the share.
Share value = expected dividend per share one year from now/(required rate of return - growth rate)
From the above table, we see that the historical dividends from the period 2010 to 2015 has grown every year. The componded annual growth rate will be:
2.87 = 2.25 * (1+r)^5 (using the compounding formula)
1.2756 = (1+r)^5
1.05 = 1+r or r = 0.05 or 5%
Thus the CAGR is 5% for the period 2010 to 2015. The growth rate for 2016 expected dividend = 5.22% (from the 2015 figures). I assume the growth rate to be 5% in perpetuity.
so, using the formula of dividend growth discount model:
Share value = expected dividend per share one year from now/(required rate of return - growth rate)
Share value = 3.02/(0.13 - 0.05) or 3.02/0.08 = $37.75. This is the price per share that i will be willing to pay.
b. if r = 10% or 0.10,
share value = 3.02/(0.10 - 0.05) or 3.02/0.05 = $60.40
c. Any decline in risk will result in a reduction in the required rate of return as expected from similar investments. This fall in required rate of return will mean that the future dividends will be a lower amount of discounting of the future dividend payouts to reflect the lower risk profile. This lower discounting will increase the present value of the share price.
Year Dividend Groth rate (current dividend - last year's dividend/last year's dividend) 2010 2.25 2011 2.37 5.333333 2012 2.46 3.797468 2013 2.6 5.691057 2014 2.76 6.153846 2015 2.87 3.985507 2016 3.02 5.226481Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.