BLT Ltd last paid a dividend of $0.20 three years ago. Today the company announced they will resume paying dividends. The planned dividends are $0.50 in one year's time, $0.60 in two years' time, and thereafter dividends will increase by a constant rate of 5% p.a. indefinitely. If the required rate of return for BLT is 12%, what is a fair price for one share today?
a) $8.30
b) $8.57
c) $8.10
d) $0.45
e) $7.65
Here
D1 = 0.50
D2 = 0.60
After D2 the dividends will grow at 5% p.a
So, D3 = D2 * (1+g) = 0.60 * 1.05 = 0.63
Present value of dividends from D3 to indifinate period at end ofyear 2 = D3 / (r -g) = 0.63 / (0.12-0.05) = $ 9.
Fiar price of share means present value of all cash flows from the stock.
PV of cash inflows from the stock :-
years | Dividends | PVF@12% | PV of dividends |
1 | 0.5 | 0.892857 | 0.446429 |
2 | 0.6 | 0.797194 | 0.478316 |
2 | 9 | 0.797194 | 7.174745 |
Fiar price of stock | 8.09949 |
Fiar price of stock = $ 8.10
Option c is correct.
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