Question

Q1/Character Co. offers a common stock that pays an annual dividend of $3.36 a share. The company has promised to maintain a constant dividend. How much are you willing to pay for one share of this stock if you want to earn a 7.82 percent return on your equity investments?

Q2/The Onboard Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 23.3 percent a year for the next 3 years and then decreasing the growth rate to 3.1 percent per year. The company just paid its annual dividend in the amount of $2.51 per share. What is the current value of one share of this stock if the required rate of return is 9 percent?

Q3/Orca, Inc. announced today that it will begin paying annual dividends. The first dividend will be paid next year in the amount of $1.94 a share. The following dividends will be $1.15, $1.57, and $2.13 a share annually for the following three years, respectively. After that, dividends are projected to increase by 3 percent per year. How much are you willing to pay today to buy one share of this stock if your required rate of return is 13.5 percent?

Answer 1

1. Present value of a constant dividend paying stock = Dividend/rate

PV = 3.36/0.0782 = $42.97

2.

D0 = 2.51

D1 = 2.51*(1+0.233) = 3.095

D2 = 3.095*(1+0.233) = 3.816

D3 = 3.816*(1+0.233) = 4.705

D4 = 4.705*(1+0.031) = 4.851

P3 = D4/(R-g) = 4.851/(0.09-0.031) = 82.22

P0 = 3.095/(1+0.09)^1 + 3.816/(1+0.09)^2 + 4.705/(1+0.09)^3 + 82.22/(1+0.09)^3 = $73.17

3.

D1 = 1.94

D2 = 1.15

D3 = 1.57

D4 = 2.13

D5 = 2.13*(1+0.03) = 2.194

P4 = D5/(R-g) = 2.194/(0.135-0.03) = 20.8943

P0 = 1.94/(1+0.09)^1 + 1.15/(1+0.09)^2 + 1.57/(1+0.09)^3 + 2.13/(1+0.09)^4 + 20.8943/(1+0.09)^4 = $20.27