Question

A company has just paid its first dividend of $3.71. Next year's dividend is forecast to grow by 9 percent, followed by another 9 per cent growth in year two. From year three onwards dividends are expected to grow by 2.2 percent per annum, indefinitely. Investors require a rate of return of 16 percent p.a. for investments of this type. The current price of the share is (round to nearest cent)

Answer #1

Statement showing Price of stock today

Year | Dividend | PVIF @ 16% | PV | |

1 | 3.71 x 1.09 | 4.04 | 0.8621 | 3 |

2 | 4.04 x 1.09 | 4.41 | 0.7432 | 3 |

Horizon value (WN 1) | 32.66 | 0.7432 | 24 | |

Price of stock today | 31 |

Thus current price of stock = $31

WN 1) Horizon Value = Dividend for year 3 /Ke-g

g= growth raet = 2.2%

Ke = required return = 16%

Dividend for year 3 = Dividend for year 2(1+g)

=4.41(1+2.2%)

=4.41(1.022)

=4.51 $

Thus, horizon value = 4.51/16%-2.2%

=4.51/13.80%

=32.66 $

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