Question

Phoenix Industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the first dividend since the crisis. Analysts expect dividends to increase by $1 a year for another 2 years. After the third year (in which dividends are $3 per share) dividend growth is expected to settle down to a more moderate long-term growth rate of 5%. If the firm’s investors expect to earn a return of 15% on this stock, what must be its price?

Answer 1

the given details are :

Year	Dividend
1	1
2	2
3	3
4	3.15 <----- (growth rate 5%)

Expected rate of return is 15%

thus the price of the stock in the 4th year needs to be calculated.

Why fourth year is because the value dividend is given till the third year after which it is expected to grow by 5%.

so the price: Dividend in next year(in 4th year)/ (Expected rate of return-growth rate)

= 3.15/(15%-5%)

= $ 31.5 /-

so post crisis the value in the fourth year will be $ 31.50 which is considered to be a very good recovery rate.

Incase of any doubt, kindly drop a comment and i will clarify your doubt.