Question

A new company, Jono's Lifeline, plans to start paying dividends in 5 years time. This first dividend will be $0.90 and thereafter the dividends will increase by 4% each year indefinitely. If the required return is 14%, what is the price of a share today?

Answer 1

price of a share today = $4.861291

Calculation :-

The First will be paid at the end of 5th Year (Denoted as D5) will be $0.90

Step 1 - Calculate Terminal Value:-

Terminal Value = D5(1 + Growth rate) / (required return - Growth rate)

Terminal Value = 0.90(1.04) / (0.14 - 0.10)

Terminal Value = 0.936 / 0.10

Terminal Value = $9.36

Step 2 - Calculate Present Value of Terminal Value to Get price of a share today :-

Since the Terminal Value is at the end of year 5 therefore we will pull Terminal Value 5 years back with required return of 14%

Present Value = ($9.36 / 1.14)5

Present Value = $4.861291

Hence,

price of a share today = $4.861291