Question

1. Far Side Corporation is expected to pay the following dividends over the next four years: $10, $8, $5, and $2. Afterward, the company pledges to maintain a constant 5 percent growth rate in dividends forever. If the required return on the stock is 11 percent, what is the current share price?

a. $51.25

b. $41.35

c.$42.71

d. $44.84

e. $43.53

Answer 1

As per Gordon's Growth model the price of share is the present value of its future dividend payments. This method is also known as Dividend Dicount Model.

Year	Cashflow	PV @ 11%	DCF
1	10	0.901	9.01
2	8	0.812	6.50
3	5	0.731	3.66
4	2	0.659	1.32
4	35(WN 1)	0.659	23.07

Total 43.56(Approx)

Working Note:

1. Terminal value of share will be calculated using following formula :

[D0*(1+g)]/(Ke - g)

=[2*(1+5%)]/(11% - 5%)

= $35

Hence the correct option is e i.e. $43.53

Note: The little difference in answer is due to rounding off the answers to nearest 2 decimal places)