Question

Integrated Potato Chips just paid a $2.3 per share dividend. You expect the dividend to grow steadily at a rate of 5% per year.

a. What is the expected dividend in each of the next 3 years? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

b. If the discount rate for the stock is 11%, at what price will the stock sell today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. What is the expected stock price 3 years from now? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

d. If you buy the stock and plan to sell it 3 years from now, what are your expected cash flows in (i) year 1; (ii) year 2; (iii) year 3? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

e. What is the present value of the stream of payments you found in part (d)? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Answer 1

a)

Expected dividend in each of the next 3 years:

Year 1 dividend = 2.3 (1 + 5%) = 2.42

Year 2 dividend = 2.3 (1 + 5%)^2 = 2.54

Year 3 dividend = 2.3 (1 + 5%)^3 = 2.66

b)

Stock price today = D1 / required rate - growth rate

Stock price today = 2.42 / 0.11 - 0.05

Stock price today = 2.42 / 0.06

Stock price today = $40.33

c)

Expected stock price in 3 years = Current value (1 + g)^n

Expected stock price in years = 40.33 (1 + 0.05)^3

Expected stock price in 3 years = 40.33 * 1.157625

Expected stock price in 3 years = $46.69

d)

Expected cash flows:

Year 1 cash flow = 2.42

Year 2 cash flow = 2.54

Year 3 cash flow = 2.66 + 46.69 = $49.35

e)

Present value of cash flows = 2.42 / (1 + 0.11)^1 + 2.54 / (1 + 0.11)^2 + 49.35 / (1 + 0.11)^3

Present value of cash flows = $40.33