Question

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.

Answer 1

Rate = 7%

Terminal Value = D3 * (1+g) / (rate - g) (this value would be consider in year 3)

D3 = 4.50

Terminal Value = 4.5 * (1+0.02)/(0.07 - 0.02) = 91.8

Stock price = Present value of future dividend and terminal value discounted at required rate.

Year	Amount	Present Value
1	3.75	3.75/(1+0.07)^1 = 3.50
2	4.25	4.25/(1+0.07)^2 = 3.71
3	4.50 + 91.8 = 96.3	96.3/(1+0.07)^3 = 78.61

Stock Price = 3.51 + 3.71 + 78.61 = 85.83 Answer

Option C is correct.