Question

Suppose that a company announced that it will pay a dividend next year of 5KD. Then the company will increase it's dividend by 6% per tear for two years after which it will maintain a constant 4% dividend growth rate. What is one share worth today at a required rate of return of 15%?

Answer 1

Value of stock means present value of all future cash flows from stock.

Here next year dividend will be 5kd. After two years dividend will be increase by 6%, after that dividend will grow at constant rate @4%

D1 = 5kd

D2 = 5kd * (1.06) = 5.3 kd

D3 = 5.3 kd * (1.06) = 5.618 kd

D4 = 5.618 * (1.04) = 5.84272 kd

From D4, dividends grow at 4% per year.

Present value of dividends from D4 at end of the D3 period = D4 / (r-g) = 5.84272 / ( 0.15 - 0.04)

Present value of dividends from D4 at end of the D3 period = 53.1156364 kd

Particulars	Dividend	PVF@15%	present value of dividends
D1	5 kd	0.869565217	4.34782609
D2	5.3 kd	0.756143667	4.00756144
D3	5.618 kd	0.657516232	3.69392619
Present value of dividends from D4 at end of the D3 period	53.1156364 kd	0.657516232	34.9243931
	Total		46.9737068

Value of stock today = 46.9737068 kd