Rocks & Wood Construction Co. recently paid $3.50 as an annual dividend. Future dividends are projected at $3.75, $4.25, and $4.50 over the next 3 years, respectively. Beginning four years from now, the dividend is expected to increase by 2% annually. What is one share of this stock worth to you today if you require a 7% rate of return?Select one:
a. $75.34
b. $78.98
c. $85.83
d. $89.69
e. None of the above.
explicit forcast period
we can find the intrinsic value(share price) during 3 years .The following formula can be used for the same :-
intrinsic value = D1 / (1+R)1 + D2 / (1+R)2 + D3 / (1+R)3 + D4 / (1+R)4
D= DIVIDENT
divident for year1,2,3 are given as $3.75, $4.25, and $4.50 respectively
R=DISCOUNTING RATE = 7%
The solution is worked out as follows :-
intrinsic value = 3.75/ (1+0.07)1 + 4.25 / (1+0.07)2 + 4.5 / (1+0.07)3
= 3.504 + 3.712 + 3.67
present value for 3 years = 10.886
horizone period
from the 4th year onwards the growth rate = 2%
formula for value at the end of 3rd year = D4 / RE-g
= 4.50 * 1.02 / 0.07-0.02
value at the end of 3rd year = 91.80
present value of 91.80 at year 0 =91.80 / 1.073
= 85.822
answer is 85.83
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