1) IBIS Corporation has had dividends grow from $2.50 per share to $6.00 per sha
ID: 2787843 • Letter: 1
Question
1) IBIS Corporation has had dividends grow from $2.50 per share to $6.00 per share over the last 10 years (the $6.00 per share dividend was paid yesterday; that is, D0 = $6.00). This compounded annual growth rate in dividends is expected to continue into the future forever. If the current market price of IBIS’s stock is $45.00 per share, what rate of return do investors expect to receive from buying IBIS stock?
2)Malcolm Manufacturing, Inc. just paid a $2.00 annual dividend (that is, D0 = 2.00). There will be no dividend payment for the next two years (i.e., at t = 1 and t = 2). In year three (t = 3), the dividend is expected to be $5.00. The dividend will then grow at 10% annually for the next 3 years (i.e., at t = 4, t = 5 and t = 6) and thereafter (i.e., beginning at t = 7) dividends will grow at a rate of 3% annually forever. Assuming a required return of 14%, what is the current price of the stock?
Explanation / Answer
1.
Find the growth rate
PV = 2.5
FV = 6
N = 10
PV = FV/(1+r)^n
PV - Present value
FV - Future value
r - Interest rate
n - no. of periods
2.5 = 6/(1+r)^10
r = 9.15%
So, the growth rate of dividends = 9.15%
According to dividend-discount model,
P0 = D1/(R-G)
P0 = Current stock price
D1 - Dividend at t =1
R - Required rate
G - Growth rate
45 = 2.5*(1+0.0915)/(R-0.0915)
R = 15.21%
Rate of return = 15.21%
2.
D0 = 2
D1 = 0
D2 = 0
D3 = 5
D4 = 5*1.1 = 5.5
D5 = 5.5*1.1 = 6.05
D6 = 6.05*1.1 = 66
D7 = 66*1.03 = 6.8547
According to dividend-discount model,
P0 = D1/(R-G)
P0 = Current stock price
D1 - Dividend at t =1
R - Required rate
G - Growth rate
P6 = D7/(R-g) = 6.8547/(0.14-0.03) =62.32
To find the present value discount the future dividedns and P6
P0 = 5/(1+0.14)^3 + 5.5/(1+0.14)^4 + 6.05/(1+0.14)^5 + 6.66/(1+0.14)^6 + 62.32/(1+0.14)^6 = 41.20
Current stock price = $41.20
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