Question

The stock of Dravo Corporation currently pays a dividend (D0) at the rate of $2 per share. This dividend is expected to increase at a 12 percent annual rate for the next 3 years, at a 11 percent annual rate for the following 2 years, and then at 10 percent per year thereafter. What is the value of a share of stock of Dravo to an investor who demands a 20 percent rate of return on this stock?

Answer 1

D1=(2*1.12)=$2.24

D2=(2.24*1.12)=$2.5088

D3=(2.5088*1.12)=$2.809856

D4=(2.809856*1.11)=$3.11894016

D5=(3.11894016*1.11)=$3.462023578

Value after year 5=(D5*Growth rate)/(Required return-Growth rate)

=(3.462023578*1.1)/(0.2-0.1)=$38.08225935

Hence value of share of stock=Future dividends*Present value of discounting factor(20%,time period)

=2.24/1.2+2.5088/1.2^2+2.809856/1.2^3+3.11894016/1.2^4+3.462023578/1.2^5+38.08225935/1.2^5

which is equal to

=$23.43(Approx).