Question

Richardson industries is growing fast, and is expected to increase its dividend by fifteen percent per year for the next four years, then 3.5% per year. Their cost of capital (required rate of return) is 15.5%. The company's latest dividend is $.20 per share. What is the value of 1 share of stock?

Answer 1

This question requires application of dividend discount model, according to which current value of share is present value of dividends expected in future.

For this question, mathematically,

where V4 is the terminal value, which is mathematically represented as:

D1 = 0.20 * (1 + 15%) = 0.2300

D2 = 0.2300 * (1 + 15%) = 0.2645

D3 = 0.2645 * (1 + 15%) = 0.3042

D4 = 0.3042 * (1 + 15%) = 0.3498

D5 = 0.3498 * (1 + 3.5%) = 0.3620

V4 = 3.0170

Now, substituting in main dividend discount formula,

V0 = 0.1991 + 0.1983 + 0.1974 + 0.1966 + 1.6953

V0 = $2.4867

V0 = $2.49