Question

Dividend Discount Model. Integrated Potato Chips just paid a $1 per share dividend. You expect the dividend to grow steadily at a rate of 4% per year.

a) What is the expected dividend in each of the next 3 years?

b) If the discount rate for the stock is 12%, at what price will the stock sell?

c) What is the expected stock price 3 years from now?

d) If you buy the stock and plan to sell it 3 years from now, what are your expected cash flows in (i) year 1; (ii) year 2; (iii)year 3?

e) What is the present value of the stream of payments you found in part (d)? Compare your answers to part (b)

Answer 1

1. Expected dividend = D(1+g) Year
1 = $1(1+0.04) = $1.04
2 = $1.04(1+0.04)=$1.08
3 =$1.08(1+0.04)=$1.12

2. If the discount rate for the stock is 12%, price the stock will sell is:
Price=(Do(1+g) ) / (Ke-g)
Where,
Do is dividend paid
g is growth rate
Ke is discount rate

Price P = ( 1(1+0.04) )/(0.12-0.04) = $13

3. Expected stock price at end of 3 years
Price P3 = current price P (1+g)^n
=$13(1+0.04)^3years
=$14.56

4. Expected cash flows calculation
Year 1 Do $1.04 $1.04
Year 2 D1 $1.08 $1.08
Year 3 D2 ( $1.12+$14.56) $16.18
( D2+P3 in above 3 rd question)

5. Present value cash flows calculation of above

Year dividend Exptd CF pv@12% = dis.CF
1 D0 $1.04 0.8928 =0.9286
2 D1 $1.08 0.7972 =0.8609
3 D2 $16.18 0.7118 =11.5169

Hence , solved

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