Question

Given the following information, calculate the current value of the stock: current dividend is $3.00, projected...

Given the following information, calculate the current value of the stock: current dividend is $3.00, projected super normal growth for three years at 20%, growth rate after year 3 should remain constant at 11% and you want to earn a 16% annual return. What should you pay for the stock?

A.$67.55

B.$83.34

C.$74.39

D.$61.46

Homework Answers

Answer #1

Calculation of the value of the Stock

Current Dividend (D0) = $3.00

Super Normal growth for next 3 years (g1) = 20% or 0.20

Growth Rate after 3 year (g2) = 11% or 0.11

Required rate of Return (r) = 16% or 0.16

Value of Share (P0) = [D1/(1+r)] + [D2/(1+r)2] + [D3/(1+r)3] + [P3/(1+r)3]

Where P0 = Present Value of Share

D1 = Dividend in year 1

D2 = Dividend in year 2

D3 = Dividend in year 3

P3 = Value of share at the end of the year 3

Calculation of Value of P3

P3 = D4/(r-g2)

= D0(1+g1)3(1+g2)/(r-g2)

= $3.00(1+0.20)3(1+0.11)/(0.16-0.11)

= $115.0848

Value of Share (P0) = [D1/(1+r)] + [D2/(1+r)2] + [D3/(1+r)3] + [P3/(1+r)3]

= [D0(1+g1)/(1+r)1] + [D0(1+g1)2/(1+r)2] + [D0(1+g1)3/(1+r)3] + [P3/(1+r)3]

= [$3.00(1+0.20)/(1+0.16)1] + [$3.00(1+0.20)2/(1+0.16)2] + [$3.00(1+0.20)3/(1+0.16)3] + [$115.0848/(1+0.16)3]

= $3.10 + $3.21 + $ 3.32 + $73.72

= $83.34

Option B is the answer.

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