Question

25.If your stock paying annual dividends will pay a dividend D₁ at t=1 of $1.06 and have a growth rate of  11% between t=1 and t=2, and with a constant growth rate of 5% thereafter into the future, what should be the value of the stock at t=0 if the expected rate of return for the stock is 7%? Notice that in this problem, expected dividends are given at t = 1, not t = 0! Answer to the nearest cent as in xx.xx and enter without the dollar sign.

Answer 1

The value is computed as shown below:

= Dividend in year 1 / ( 1 + required rate of return)¹ + Dividend in year 2 / ( 1 + required rate of return)² + 1 / ( 1 + required rate of return)² [ ( Dividend in year 2 (1 + growth rate) / ( required rate of return - growth rate) ]

= $ 1.06 / 1.07 + ($ 1.06 x 1.11) / 1.07² + 1 / 1.07² x [ ($ 1.06 x 1.11 x 1.05) / (0.07 - 0.05) ]

= $ 1.06 / 1.07 + $ 1.1766 / 1.07² + 1 / 1.07² x $ 61.7715

= $ 55.97 Approximately

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