Question

Combined Communications is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 21 percent a year for the next 4 years and then decreasing the growth rate to 5 percent per year. The company just paid its annual dividend in the amount of $1.10 per share. What is the current value of one share of this stock if the required rate of return is 8.50 percent? $52.25 $45.73 $57.36 $56.86

Answer 1

This question is an application of dividend discount model, according to which current value of share is present value of dividends expected in future.

where V4 is the terminal value for constant growing dividends starting year 5.

In order to use this model, we need to calculate the dividends D1 - D5.

D1 = $1.10 * (1 + 21%) = 1.3310

D2 = $1.3310 * (1 + 21%) = 1.6105

D3 = $1.6105 * (1 + 21%) = 1.9487

D4 = $1.9487 * (1 + 21%) = 2.3579

D5 = $2.3579 * (1 + 5%) = 2.4758

V0 = $56.86 --> Answer