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.

a. Suppose a company currently pays an annual dividend of $2.80 on its common stock in a single annual installment, and management plans on raising this dividend by 5 percent per year indefinitely. If the required return on this stock is 12 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Current share price $?

b. Now suppose the company in (a) actually pays its annual dividend in equal quarterly installments; thus, this company has just paid a dividend per share of $.70, as it has for the previous three quarters. What is your value for the current share price now? (Hint: Find the equivalent annual end-of-year dividend for each year.) (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Current share price

Answer 1

1)Current Market Price= Current Dividend(1+ Growth)/Required return-Growth)

=2.8(1+0.05)/(0.12-0.05)

=$ 42.00

2) If Company pays quarterly dividend that means it will 4 times dividend in a year.

Quarterly Dividend= 2.8(1.05)/4

=0.735

We have assumed here that the quarterly dividend will invested back with the required rate of return. Therefore we need to calculate the quarterly Effective rate.

Quarterly effective rate= -1 = .0287

We need to calculate effective Annual dividend using Quarterly effective rate

=$0.735 (,4%)

=$0.735*4.1755

=$ 3.07

Stock Price= $3.07/(0.12-.05)

=$43.86