Question

The aznac corporation plans to be in business for next 30 years. They announced that they will pay a divided of $3 per share at the end of 1 year
a) and continue increasing the annual dividend by 4% per year until they liquidate the company at the end of 30 years. If you want to earn a rate of return of 12% by investing in their stock, how much should you pay for the stock?

b) If the company announced that they will coutinue increasing the dividend by 4% per year forever, how much more you would be willing to pay for its stock, assuming your required rate of return is still 12% ?

Answer 1

Answer a.

Dividend in Year 1 = $3.00
Growth Rate = 4%
Required Return = 12%
Time Period = 30 years

Stock Price = $3.00/1.12 + $3.00*1.04/1.12^2 + ... + $3.00*1.04^28/1.12^29 + $3.00*1.04^29/1.12^30
Stock Price = $3.00 * [1 - (1.04/1.12)^30] / [0.12 - 0.04]
Stock Price = $3.00 * 11.14678
Stock Price = $33.44

Answer b.

Dividend in Year 1 = $3.00
Growth Rate = 4%
Required Return = 12%

Stock Price = Dividend in Year 1 / (Required Return - Growth Rate)
Stock Price = $3.00 / (0.12 - 0.04)
Stock Price = $3.00 / 0.08
Stock Price = $37.50