Question

1. After careful research, you estimate that each of two stocks will be worth $100 in 3 years.

• Stock A pays a dividend of $4 per year and is expected to stay at this level for the next 3 years.
• Stock B pays an annual dividend of $4 currently but it is expected to increase at a rate of 10% per year for 3 years.

What is the price today of both Stock A and Stock B, assuming a 6.5% required rate of return?

Answer 1

Computing current share price by discounting the cashflow at required return

- Stock A

Year	Cash flow	[email protected]%	Present Value (Cashflow*PVF)
1	4	0.939	3.76
2	4	0.882	3.53
3	104	0.828	86.10

current share price = Cashflow*PVF

= 3.76+3.53+86.09

= 93.38

- Stock B

Year	Cash flow	[email protected]%	Present Value (Cashflow*PVF)
1	(4*1.1) 4.40	0.939	4.13
2	(4*1.1^2) 4.84	0.882	4.27
3	(4*1.1^3) 105.32	0.828	87.19

current share price = Cashflow*PVF

= 4.13+4.27+87.19

= 95.59