Question

Lohn Corporation is expected to pay the following dividends over the next four years: $11, $7, $6, and $3. Afterward, the company pledges to maintain a constant 6 percent growth rate in dividends forever. If the required return on the stock is 13 percent, what is the current share price?

$46.62

$49.08

$47.74

$50.55

Answer 1

The current value of the stock is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)1 + Dividend in year 2 / (1 + required rate of return)2 + Dividend in year 3 / (1 + required rate of return)3 + Dividend in year 4/ (1 + required rate of return)4 + 1 / (1 + required rate of return)4[ ( Dividend in year 4 (1 + growth rate) / ( required rate of return - growth rate) ]

= $ 11 / 1.13 + $ 7 / 1.132 + $ 6 / 1.133 + $ 3 / 1.134 + 1 / 1.134 x [ ($ 3 x 1.06) / (0.13 - 0.06) ]

= $ 11 / 1.13 + $ 7 / 1.132 + $ 6 / 1.133 + $ 3 / 1.134 + $ 45.42857143 / 1.134

= $ 11 / 1.13 + $ 7 / 1.132 + $ 6 / 1.133 + $ 48.42857143 / 1.134

= $ 49.08 Approximately