Question

1. A company’s dividend grows at a constant rate of 5 percent p.a.. Last week it paid a dividend of $1.47. If the required rate of return is 16 percent p.a., what is the price of the share 4 years from now? (round to nearest cent)

Select one:

a. $17.06

b. $16.24

c. $9.42

d. $25.41

2. After paying a dividend of $1.90 last year, a company does not expect to pay a dividend for the next year. After that it plans to pay a dividend of 6.69 in year 2 and then increase the dividend at a rate of 3 percent per annum in years 3 to 6. What is the expected dividend to be paid in year 5? (to nearest cent; don't include $ sign)

3. You are interested in investing in a company that expects to grow steadily at an annual rate of 3 percent for the foreseeable future. The company just paid a dividend of $4.04. If your required rate of return is 18 percent p.a., what is the most you would be willing to pay for this share? (Round to the nearest cent; don't use $ sign.)

Answer 1

Answer : Correct option is 17.06

Reason :

Calculation of Price in Year 4

Price in year 4 = Dividend in year 5 / (Required Rate of return - Growth rate)

= D0 * (1 + growth rate)^5 / [Required Rate of return - Growth rate]

= [1.47^5] / [0.11 - 0.05]

= 1.8761 / 0.11

= 17.06

Answer : 2) Calculation of Expected Dividend in year 5

Expected Dividend in year 5 = Dividend in year 2 * (1 + growth rate)^3

= 6.69 * (1 + 0.03)^3

= 7.31

Answer : 3) Calculation of price :

Price = Expected Dividend / (Expected Return - Growth rate)

= 4.04 * (1 + 0.03) / [0.18 - 0.03]

= 4.1612 / 0.15

= 27.74