Question

ABC Inc., will pay no dividends over the next 13 years because the firm needs to...

ABC Inc., will pay no dividends over the next 13 years because the firm needs to retain its earnings for growth purposes. The company will pay an $4 per share dividend in 14 years and will increase the dividend by 4 percent per year thereafter. If the required return on this stock is 9 percent, what is the current (t=0) share price?

ABC Inc. just paid a dividend of $1.75 per share. The company will increase its dividend by 28 percent next year and will then reduce its dividend growth rate by 7 percentage points per year until it reaches the industry average of 7 percent dividend growth, after which the company will keep a constant growth rate forever. If the required return on the stock is 12 percent, what will a share of stock sell for today?

Homework Answers

Answer #1

Answer to Question 1:

Dividend Year 14, D14 = $4.00
Growth Rate, g = 4%
Required Return, rs = 9%

Stock Price Year 13, P13 = D14 / (rs - g)
Stock Price Year 13, P13 = $4.00 / (0.09 - 0.04)
Stock Price Year 13, P13 = $4.00 / 0.05
Stock Price Year 13, P13 = $80.00

Current Stock Price, P0 = P13 / (1 + rs)^13
Current Stock Price, P0 = $80.00 / 1.09^13
Current Stock Price, P0 = $26.09

Answer to Question 2:

Last Dividend, D0 = $1.75

Growth Rate, Year 1 = 28%
Growth Rate, Year 2 = 21%
Growth Rate, Year 3 = 14%
Growth Rate, Year 4 and onward (g) = 7%

D1 = $1.75 * 1.28 = $2.24
D2 = $2.24 * 1.21 = $2.7104
D3 = $2.7104 * 1.14 = $3.0899
D4 = $3.0899 * 1.07 = $3.3061

Required Return, rs = 12%

P3 = D4 / (rs - g)
P3 = $3.3061 / (0.12 - 0.07)
P3 = $3.3061 / 0.05
P3 = $66.122

Current Stock Price, P0 = $2.24/1.12 + $2.7104/1.12^2 + $3.0899/1.12^3 + $66.122/1.12^3
Current Stock Price, P0 = $53.42

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