Question

Twenty years ago, Video Toys began manufacturing and selling coin-operated arcade games. Dividends are currently $2.80 per share, having grown at a 14% percent compound annual rate over the past 10 years. That growth rate is expected to be maintained for the next 2 years, after which dividends are expected to grow at half that rate for 3 years. Beyond that time, Video Toys's dividends are expected to grow at 5 percent per year. What is the current value of a share of Video Toys common stock if your required rate of return is 22%?

Question 12 options:

	$21.73
	$20.92
	$27.53
	$24.38

Answer 1

Growth rate from year 1 and year 2 =14%
Growth rate from year 3 to 5 =7%
Growth rate after year 5 =5%
D1 =2.80*1.14
D2 =2.80*1.14^2
D3 =2.80*1.14^2*1.07
D3 =2.80*1.14^2*1.07^2
D5=2.80*1.14^2*1.07^3*1.05
Terminal Value =Dividend Year 6/(Required -growth) =2.80*1.14^2*1.07^3*1.05/(22%-5%)=27.5334

Price of Stock =2.80*(1+14%)/(1+22%)+2.80*(1+14%)^2/(1+22%)^2+2.80*(1+14%)^2*(1+7%)/(1+22%)^3+2.80*(1+14%)^2*(1+7%)^2/(1+22%)^4+2.80*(1+14%)^2*(1+7%)^3/(1+22%)^5+27.5334/(1+22%)^5 =20.92(Option b is correct option)