Question

Mack Industries just paid a dividend of $5 per share (D0 = $5). Analysts expect the

company’s dividend to grow 7 percent this year (D1 = $5.35) and 5 percent next year.  

After two years the dividend is expected to grow at a constant rate of 5 percent.  The

required rate of return on the company’s stock is 15 percent.  What should be the

company’s current stock price?

Answer 1

Step 1)Calculation of D2 and horizon value at year 2

Dividend for year 2= D1(1+g)

= 5.35(1+.05)= 5.6175

Horizon value =D2/(1+g)/(rs-g)

= 5.6175(1+.05)/(.15-.05)

= 5.6175*1.05 /.10

= 58.98375

Step 2)calculation of current price= [PVF15%,1*D1]+[PVF15%,2*D2]+[PVF15%,2*Horizon value]

=[.86957*5.35]+[.75614*5.6175]+[.75614*58.98375]

= 4.6522+ 4.2476+ 44.60

= 53.50 per share

current price = $ 53.50 per share

#working

Find PVF using present value factor table or using the formula 1/(1+i)^n where i =15% n=1,2