Most corporations pay quarterly dividends on their common stock rather than annu

Question

Most corporations pay quarterly dividends on their common stock rather than annual dividends. Barring any unusual circumstances during the year, the board raises, lowers, or maintains the current dividend once a year and then pays this dividend out in equal quarterly installments to its shareholders. Suppose a company currently pays an annual dividend of $4.00 on its common stock in a single annual installment, and management plans on raising this dividend by 2 percent per year indefinitely. If the required return on this stock is 14 percent, what is the current share price? Now suppose the company in (a) actually pays its annual dividend in equal quarterly installments; thus, the company has just paid a dividend of $1.000 per share, as it has for the previous three quarters. What is your value for the current share price now?

Explanation / Answer

Stock price = D1÷(r-g)

D1 is next expected dividend

r is cost of common stock

g is growth rate

a)

= $4×(1+2%)÷(14%-2%)

= $34

b)

Equivalent annual dividend (D0)

= $1+$1×(1+14%÷4)^3+$1×(1+14%÷4)^2+$1×(1+14%÷4)

= $4.22

Share price = $4.22×(1+2%)÷(14%-2%)

= $35.87

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