Question

Question

Cory’s Candies Inc. has just paid $2.40 in dividends (D₀ = $2.40). The firm is expected to continue paying dividends in perpetuity.

1. Suppose that the dividends are constant (D_i = $2.40 for all i). What will be the stock price of a share of Cory’s Candies Inc. in 22 years If the required rate of return is 10.5 percent?
2. Suppose that the dividends are expected to grow by 4 percent each year in perpetuity. What will be the price of a share of Cory’s Candies Inc. in 22 years if the required rate of return is 10.5 percent? What will be the price in 18 years and in 28 years?

Answer 1

Answer to Part a.

Dividend = $2.40
Growth rate, g = 0.00%
Required return, r = 10.50%

Stock Price = Dividend / (Required Return - Growth Rate)
Stock Price = $2.40 / (0.1050 - 0)
Stock Price = $22.86

Stock Price will remain same, as the Growth rate is 0 percent. So, stock price in 22 years is $22.86

Answer to Part b.

D0 = $2.40
Growth rate, g = 4.00%
Required return, r = 10.50%

D1 = D0 * (1 + g)
D1 = $2.40 * 1.04 = $2.496

P0 = D1 / (r - g)
P0 = $2.496 / (0.1050 - 0.0400)
P0 = $38.40

P22 = P0 * (1 + g)^22
P22 = $38.40 * 1.04^22
P22 = $91.00

Stock price in 22 years is $91.00

P18 = P0 * (1 + g)^18
P18 = $38.40 * 1.04^18
P18 = $77.79

Stock price in 18 years is $77.79

P28 = P0 * (1 + g)^28
P28 = $38.40 * 1.04^28
P28 = $115.15

Stock price in 28 years is $115.15