Question

A company is expecting its sales to decline and has announced that it will be reducing its annual dividend by 7.25% a year for the next two years. After that, it will maintain a constant dividend of $1.00 a share. Just recently, the company paid a dividend of $3.10 per share. What is this stock worth if you require an 11.25% rate of return?

Answer 1

Given about a company,

Most recent dividend D0 = $3.1

dividend are expected to decrease at the rate of 7.25% a year for next 2 years

So, D1 = 3.1*(1-0.0725) = $2.8753

D2 = 2.8753*(1-0.0725) = $2.6668

thereafter, company will maintain constant dividend of D = $1

required rate of return r = 11.25%

So, Value of stock at year 2 using perpetual model is

P2 = D/r = 1/0.1125 = $8.8889

So, present value of stock is sum of PV of future dividends and P2 discounted at r

=> P0 = D1/(1+r) + D2/(1+r)^2 + P2/(1+r)^2

=> P0 = 2.8753/1.1125 + 2.6668/1.1125^2 + 8.8889/1.1125^2 = $11.92

So, current market value of this stock is $11.92