Question

Magnetic Corporation expects dividends to grow at a rate of 16.40% for the next two years. After two years dividends are expected to grow at a constant rate of 06.40% indefinitely. Magnetic’s required rate of return is 12.98% and they paid a $2.06 dividend today. Find the value of Magnetic Corporation’s common stock per share by computing:

a) Dividend at the end of Year 1:

b) Dividend at the end of Year 2:

c) Dividend at the end of Year 3:

d) Price of stock at the end of Year 2:

e) Price of stock today:

Answer 1

1)

Dividend at the end of Year 1 = 2.06 (1 + 16.40%)

Dividend at the end of Year 1 = $2.40

2)

Dividend at the end of Year 2 = 2.40 (1 + 16.40%)

Dividend at the end of Year 2 = $2.79

3)

Dividend at the end of Year 3 = 2.79 (1 + 6.40%)

Dividend at the end of Year 3 = $2.97

4)

Price of stock at the end of Year 2 = Year 3 dividend / required rate - growth rate

Price of stock at the end of Year 2 = 2.97 / 0.1298 - 0.064

Price of stock at the end of Year 2 = 2.97 / 0.0658

Price of stock at the end of Year 2 = $45.14

5)

Present value = Future value / (1 + rate)^time

Price of stock today = Present value of cash inflows

Price of stock today = 2.4 / (1 + 0.1298)^1 + 2.79 / (1 + 0.1298)^2 + 45.14 / (1 + 0.1298)^2

Price of stock today = $39.67