Question

kindsor Natural Foods' current dividend is $7.00. You expect the growth rate to be 0 percent for years 1 to 5, and 1 percent for years 6 to infinity. The required rate of return on this firm’s equity is 11 percent.

1. Determine the expected price of the stock at the end of year 5 (immediately after the year 5 dividend). (Round answer to 2 decimal places, e.g. 45.17.)

2. Determine the price of the stock today. (Round answer to 2 decimal places)

Answer 1

1. The price is computed as follows:

= Dividend in year 6 / (required rate of return - growth rate)

= ($ 7 x 1.01) / (0.11 - 0.01)

= $ 7.07 / 0.10

= $ 70.70

2. The price is computed as follows:

= Dividend in year 1 / (1 + rate of return)¹ + Dividend in year 2 / (1 + rate of return)² + Dividend in year 3 / (1 + rate of return)³ + Dividend in year 4 / (1 + rate of return)⁴ + Dividend in year 5 / (1 + rate of return)⁵ + 1 / (1 + rate of return)⁵ x [ (Dividend in year 5 x (1 + growth rate) ] / (rate of return - growth rate) ]

= $ 7 / 1.11¹ + $ 7 / 1.11² + $ 7 / 1.11³ + $ 7 / 1.11⁴ + $ 7 / 1.11⁵ + 1 / 1.11⁵ x [ ($ 7 x 1.01) / (0.11 - 0.01) ]

= $ 7 / 1.11¹ + $ 7 / 1.11² + $ 7 / 1.11³ + $ 7 / 1.11⁴ + $ 7 / 1.11⁵ + $ 70.70 / 1.11⁵

= $ 7 / 1.11¹ + $ 7 / 1.11² + $ 7 / 1.11³ + $ 7 / 1.11⁴ + $ 77.70 / 1.11⁵

= $ 67.83

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