XYZ Corporation is expected to pay a dividend in Year 1 of $3.00, a dividend in Year 2 of $2.00, and a dividend in Year 3 of $1.00. After Year 3, dividends are expected to decline at the rate of 2% per year. An appropriate required return for the shares is 8%. How much the shares should be worth today?
Share price today is $ 13.07
| As per dividend discount method, current share price is the present value of future dividends. | ||||||
| Step-1:Present value of dividend of next three years | ||||||
| Year | Dividend | Discount factor | Present value | |||
| a | b | c=1.08^-a | d=b*c | |||
| 1 | $ 3.00 | 0.9259 | $ 2.78 | |||
| 2 | $ 2.00 | 0.8573 | $ 1.71 | |||
| 3 | $ 1.00 | 0.7938 | $ 0.79 | |||
| Total | $ 5.29 | |||||
| Step-2:Calculation of terminal value of dividend at the end of three years | ||||||
| Terminal value | = | D3*(1+g)/(Ke-g)*DF3 | Where, | |||
| = | $ 7.78 | D3(Dividend of year 3) | = | $ 1.00 | ||
| g (Growth rate in dividend) | = | -2% | ||||
| Ke (Required return) | = | 8% | ||||
| DF3 (Discount factor of year 3) | = | 0.7938 | ||||
| Step-3:Sum of present value of future dividends | ||||||
| Sum of present value of future dividends | = | $ 5.29 | + | $ 7.78 | ||
| = | $ 13.07 | |||||
| So, Price of stock is | $ 13.07 | |||||
Get Answers For Free
Most questions answered within 1 hours.