Question

"Q4) Magnetic Corporation expects dividends to grow at a rate of 10.50% for the next two years. After two years dividends are expected to grow at a constant rate of 06.70% indefinitely. Magnetic’s required rate of return is 13.36% and they paid a $1.83 dividend today. d) Price of stock at end of year 2: e) Price of stock today:

Answer 1

Question:

Current Dividend = D0 = $1.83

g1 = growth rate = 10.50%

g2 = growth rate = 6.70%

Dividend in Year 1 = D1 = D0 * (1+g) = $1.83 * (1+10.50%) = $2.02215

Dividend in Year 2 = D2 = D1 * (1+g) = $ 2.02215 * (1+10.5%) = $2.23447575

Dividend in Year 3 = D3 = D2 * (1+g) = $2.23447575 * (1+6.70%) = $2.38418563

r = requierd return = 13.36%

Price of stock at the end of year 2 = D3 / (r - g2)

= $2.38418563 / (13.36% - 6.70%)

= $2.38418563 / 0.0666

= $35.798583

Price of stock at the end of year 2 is $35.80

Question:

Price of Stock today = [D1 / (1+r)^1] + [D2 / (1+r)^2] + [Price at the end of year 2 / (1+r)^2]

= [$2.02215 / (1+13.36%)^1] + [$2.23447575 / (1+13.36%)^2] + [$35.798583 / (1+13.36%)^2]

= [$2.02215 / 1.1336] + [$2.23447575 / 1.28504896] + [$35.798583 / 1.28504896]

= $1.78383028 + $1.73882538 + $27.857758

= $31.3804137

Therefore, Price of stock today is $31.38