Question

Wii U announced today that it will begin paying annual dividends. The first dividend will be paid next year in the amount of $1 a share. The following dividends will be $1.2, and $1.37 a share annually for the following two years, respectively. After that, dividends are projected to increase by 4 percent per year. How much are you willing to pay today to buy one share of this stock if your desired rate of return is 12 percent?

Answer 1

Given about Wii U company,

first dividend next year D1 = $1.00

dividend in year 2 D2 = $1.20

dividend in year 3 D3 = $1.37

thereafter dividend growth rate g = 4%

desired return on stock rs = 12%

Using constant dividend growth rate. price at year 3 end is

P3 = D3*(1+g)/(rs-g)

P3 = 1.37*1.04/(0.12-0.04) = $17.81

Price of stock today is sum of PV of future dividends and P3 discounted at rs

=> P0 = D1/(1+rs) + D2/(1+rs)^2 + D3/(1+rs)^3 + P3/(1+rs)^3

=> P0 = 1/1.12 + 1.20/1.12^2 + 1.37/1.12^3 + 17.81/1.12^3 = $15.50

So, current stock price is $15.50