Question

What is the expected dividend to be paid in the first 3 years if yesterday's dividend was $6.00 (D₀), dividends are expected to grow at 20% in year 1, 10% in year 2 and after that its growth is at a constant growth rate 6%? What will be the current market price? Assume the firm has a 12% expected return?

Answer 1

1)

Year 1 dividend = 6 (1 + 20%)

Year 1 dividend = $7.2

2)

Year 2 dividend = 7.2 (1 + 10%)

Year 2 dividend = $7.92

3)

Year 3 dividend = 7.92 (1 + 6%)

Year 3 dividend = $8.3952

4)

Value at year 2 = D3 / required rate - growth rate

Value at year 2 = 8.3952 / 0.12 - 0.06

Value at year 2 = 8.3952 / 0.06

Value at year 2 = 139.92

Current market price = Present value of cash flows

Current market price = 7.2 / (1 + 0.12)^1 + 7.92 / (1 + 0.12)^2 + 139.92 / (1 + 0.12)^2

Current market price = $124.29