Question

1. Hot Wings, Inc. has just paid a dividend of $2 per share and has announced that it will increase the dividend by $5 per share for each of the next 5 years. If you want a return of 9 percent per year, how much will you pay for the stock?

Answer 1

Recent Dividend, D0 = $2.00

Dividend in Year 1, D1 = $2.00 + $5.00
Dividend in Year 1, D1 = $7.00

Dividend in Year 2, D2 = $7.00 + $5.00
Dividend in Year 2, D2 = $12.00

Dividend in Year 3, D3 = $12.00 + $5.00
Dividend in Year 3, D3 = $17.00

Dividend in Year 4, D4 = $17.00 + $5.00
Dividend in Year 4, D4 = $22.00

Dividend in Year 5, D5 = $22.00 + $5.00
Dividend in Year 5, D5 = $27.00

Required Return, rs = 9.00%

Current Price = D1/(1+rs) + D2/(1+rs)^2 + D3/(1+rs)^3 + D4/(1+rs)^4 + D5/(1+rs)^5
Current Price = $7.00/1.09 + $12.00/1.09^2 + $17.00/1.09^3 + $22.00/1.09^4 + $27.00/1.09^5
Current Price = $62.78

Therefore, you would have to pay $62.78 for the stock.