Question

Fronczak Pharmaceuticals just paid (an instant ago) its annual dividend of $.20 a share. Future annual dividends are forecast to equal $.30 (t=1), $.50 (t=2) , $.75 (t=3), $1.00 (t=4), and $1.20 (t=5). After that, dividends are expected to remain at $1.40 (from t=6, onwards). At what price will the stock sell today if stockholder required return is 14 percent per year?

Answer 1

Step 1: Calculation of present value of the Dividends

  

Year	Dividend	Disc @ 14 %	Present value of the Dividend
1	$0.30	0.8772	$0.26
2	$0.50	0.7695	$0.38
3	$0.75	0.6750	$0.51
4	$1.00	0.5921	$0.59
5	$1.20	0.5194	$0.62
		Total	$2.37

Step 2:  From Year 6, Dividend is expected to remain at $ 1.40

That means there is no growth in Dividend from year

Value of the Share at the end of 5 th year is sum of the discounted cash inflows of the further year

Value of the share at the end of 5th year =  D6/r

= $ 1.40/0.14

= $ 10

Present value of the share as on today =  [ $ 10/ ( 1.14)^5]

= $ 5.1936

  Value of the Share price as on today = Sum of the discounted value of all future cash flows

= $ 2.37+$ 5.1936

= $ 7.5636