Question

integrated Potato Chips just paid a $2.1 per share dividend. You expect the dividend to grow steadily at a rate of 6% per year.

a. What is the expected dividend in each of the next 3 years? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

b. If the discount rate for the stock is 10%, at what price will the stock sell today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. What is the expected stock price 3 years from now? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

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? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

e. What is the present value of the stream of payments you found in part (d)? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Answer 1

a. Current dividend = D0 = 2.1

D1 =2.1*1.06 = 2.226 = 2.23

D2 = 2.226*1.06 = 2.35956 = 2.36

D3 = 2.35956*1.06 = 2.5011336 = 2.50

b. Current Stock price = D1/(r-g) = 2.226/(0.10-0.06) = $55.65

c. Stock price 3 years from now = D4/(r-g) = D3*(1+g)/(r-g) = 2.5011336*1.06/(0.10-0.06) = $66.28

d. Cash flow in year 1 = D1- purchase price = 2.226 - 55.65 = -53.42(negtaive)

Cash flow in year 2 = D2 = 2.36

Cash flow in year 3 = D3 + sale proceeds = 2.50 + 66.28 = 68.78

e. Present value of payments in (d)

2.226/1.10 + 2.36/1.10^2 + 2.50/1.10^3 + 66.28/1.10^3 = $55.65 which is the same as the current stock price