Question

Show your work in solving the problem

1. Membo just paid a dividend of $2.2 per share. Dividends are expected to grow at 7%, 6%, and 4% for the next three years respectively. After that the dividends are expected to grow at a constant rate of 3% indefinitely. Stockholders require a return of 8 percent to invest in Membo’s common stock. Compute the value of Membo’s common stock today.

Answer 1

Value = Dividend1/(1+r)^n + Dividend2/(1+r)^2 + Dividend3/(1+r)^3 + [Dividend4/r - g4) / (1+r)^3

Dividend 1 = dividend (1+growth rate1) = 2 (1.07) = 2.354

Dividend 2 = dividend1 (1+growth rate2) =354 (1.06) = 2.4952

Dividend 3 = dividend2 (1+growth rate3)= 4952 (1.04) = 2.595

Dividend 4 = dividend3 (1+growth rate4)= 2.595 (1.03) = 2.6729

Now put the values in the formula

= 2.354/(1.08)^1 + 2.4952/(1.08)^2 + 2.595/(1.08)^3 + [2.6729/0.08 - 0.03] / (1.08)^3

= 2.354/1.08 + 2.4952/1.1664 + 2.595/1.2597 + [2.6729/0.05] / 1.2597

= 2.1796 + 2.1393 + 2.0601 + 53.458/1.2597

= 6.3789 + 48.8161

= $55.195

Note:- answer might differ a bit due to rounding off