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Ray Inc. company is not expected to pay any dividends for three years while it attempts...

Ray Inc. company is not expected to pay any dividends for three years while it attempts to restructure its business. They anticipate paying $1.30 in year four and thereafter growing at a rate of 6%. What should we pay for the stock if we demand a 14% rate of return?

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Answer #1

First of all let's find horizon value

Horizon value = Dividend of year 5/Ke-g

Ke = required rate of return = 14%

g = growth rate = 6%

Dividend of year 5 = Dividend of year 4(1+g)

=1.3(1+6%)

=1.3(1+0.06)

=1.3(1.06)

=1.3780$

Thus Horizon Value = 1.3780/14%-6%

=1.3780/8%

=17.2250$

Statement showing value of stock today

Year Dividend PVIF @ 14% PV
1 0.8772 0.00
2 0.7695 0.00
3 0.6750 0.00
4 1.3000 0.5921 0.77
P4/Horizon value 17.2250 0.5921 10.20
Price of stock today 10.97

Thus one should pay $10.97 today for the stock

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