Question

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

Answer #1

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 | [email protected]% | 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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