Problem 4: Advanced Dividend Growth Models (7 points) A company\'s stock current

Question

Problem 4: Advanced Dividend Growth Models (7 points) A company's stock currently doesn't pay any dividends because it has good investment opportunities internally. It is considering two potential plans for the future: (i) Pay no dividends for the next 5 years, investing all earnings into growing the company. Six years from today, pay the first annual dividend. The expected size of this first dividend is S0.50 per share, and dividends will subsequently grow at an average rate of 4% per year. Investors' required rate of return over the first five years will be 12% and subsequently will be a constant 8%. (ii) Pay a $0.10 dividend in one year, and grow that dividend at 25% per year for the following four years (up through the fifth dividend). Starting in the sixth year, slow dividend growth down to an average of 4% per year. Investors' required rate of return over the first five years will be 10%, and subsequently will be a constant 8% (a) What would be the share price today if the company implemented plan (i)? Share price today:

Explanation / Answer

a)first let us find the price of the stock at 5 years then find it to the todays price
=dividend*(1+g)/(k-g)
=0.5*(1+4%)/(8%-4%)
=13
the stock price today=13/(1+12%)^5
=7.38

b)first year=0.1
2nd year=0.1*1.25=0.125
3rd year=0.1*1.25^2=0.156
4th year=0.1*1.25^3=0.195
5th year=0.1*1.25^4=0.244
terminal value=(0.1*1.25^4)*(1+4%)/(8%-4%)
=6.348
present value=(0.1/1.1^1)+(0.125/1.1^2)+(0.156/1.1^3)+(0.195/1.1^4)+((0.244+6.348)/1.1^5)
=4.54

c)Plan i since it is having higher inrinsic value

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