Question

Paper Corporation currently pays a dividend of $2 per share, and this dividend is expected to grow at a 15 percent annual rate for
three years, and then at a 10 percent rate for the next three years, after which it is expected to grow at a 5 percent rate forever. What
value would you place on the stock if an 18 percent rate of return was required? (make a timeline)

Answer 1

Timeline:

Year 1 dividend = 2 (1 + 15%) = 2.3

Year 2 dividend = 2.3 (1 + 15%) = 2.645

Year 3 dividend = 2.645 (1 + 15%) = 3.04175

Year 4 dividend = 3.04175 (1 + 10%) = 3.345925

Year 5 dividend = 3.345925 (1 + 10%) = 3.680518

Year 6 dividend = 3.680518 (1 + 10%) = 4.04857

Year 7 dividend = 4.04857 (1 + 5%) = 4.250999

Time line ends.

Value at year 6 = D7 / required rate - growth rate

Value at year 6 = 4.250999 / 0.18 - 0.05

Value at year 6 = 4.250999 / 0.13

Value at year 6 = 32.699992

Value of stock = Present value of cash inflows

Value of stock = 2.3 / (1 + 0.18)^1 + 2.645 / (1 + 0.18)^2 + 3.04175 / (1 + 0.18)^3 + 3.345925 / (1 + 0.18)^4 + 3.680518 / (1 + 0.18)^5 + 4.04857 / (1 + 0.18)^6 + 32.699992 / (1 + 0.18)^6

Value of stock = $22.65