Question

You expect GDL to pay a dividend of $2.63 in one year, $3.36 in two years and $5.12 in 3 years. After that, you think dividends will grow at a constant rate of 5.8%. You require a return of 11.7% to invest in GDL. How much would you pay for a share of the company today?

Round your answer to two decimal places.

Answer 1

Present value (PV) = sum of present value of all future cash flows

Assuming returns are generated from dividends only,

After end of 3 years there is a perpetuity model with constant dividend growth which can be calculated using the formula Dividend * (1+ dividend growth rate)/ (return rate - growth rate) which needs to be discounted back from year 3 to year 0 (present value)

PV = 2.63/(1+11.7%)^1+3.36/(1+11.7%)^2+5.12/(1+11.7%)^3+ 5.12*(1+5.8%)/(11.7%-5.8%)/(1+11.7%)^3=$74.6

So I would pay not more than $74.6 per share and preferably less (if possible)