Question

As a result of an incessant fight for market share with Middle Earth Inc, Sauron Enterprises has recently witnessed a period of depressed earnings performance Consequently, cash dividend payments have been suspended. Investors do not anticipate a resumption of dividends until four years from today, when a yearly of $1.50 will be paid. That yearly dividend is expected to be increased to $1.85 in the following year and $2.25 in the year after that. Beyond the time when the dividend is paid, investors expect Sauron's dividends to grow at an annual rate of 4.5 percent into perpetuity. All dividends are paid at the end of each year, if yo require a 15 percent rate of return on Sauron's stock, what is the value of one share of this stock to you today?

Answer 1

- Dividends until 4 years from today(D4) = $1.50

Dividend in the following year (D5) = $1.85

Dividend in 6th year(D6) = $2.25

Growth rate of Dividend thereafter in perpetuity(g) = 4.5%

Required rate of return(Ke) = 15%

First, we will Calculate the Price of Stock in 3 years from today:-

P3 = 1.3043 + 1.3989 + 1.4794 + 14.7237

P3 = $18.9063

So, Price of Stock 3 years from today is $18.9063

Now, Calculating the Price of Stock today using P3:-

P0 = P3/(1+r)^3

P0 =$18.9063/(1+0.15)^3

P0 = $12.43

So, the value of one share of this stock to you today is $12.43

If you need any clarification, you can ask in comments.     

If you like my answer, then please up-vote as it will be motivating