Question

The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning to start paying dividends. The initial dividend is to be paid in one year in the amount of $.27 a share. The dividends to be paid over each of the next three years are $.32, $.47, and $.77 respectively. After this time, dividends are expected to grow by 2.3 percent per year. How much are you willing to pay today to buy one share of this stock if your desired rate of return is 12 percent?

Answer 1

The price is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + Dividend in year 4/ (1 + required rate of return)⁴ + 1 / (1 + required rate of return)⁴[ ( Dividend in year 4 (1 + growth rate) / ( required rate of return - growth rate) ]

= $ 0.27 / 1.12 + $ 0.32 / 1.12² + $ 0.47 / 1.12³ + $ 0.77 / 1.12⁴ + 1 / 1.12⁴ [ ($ 0.77 x (1 + 0.023) / (0.12 - 0.023) ]

= $ 0.27 / 1.12 + $ 0.32 / 1.12² + $ 0.47 / 1.12³ + $ 0.77 / 1.12⁴ + 1 / 1.12⁴ x $ 8.120721649

= $ 0.27 / 1.12 + $ 0.32 / 1.12² + $ 0.47 / 1.12³ + $ 8.890721649 / 1.12⁴

= $ 6.48 Approximately