Question

Far Side Corporation is expected to pay the following dividends over the next four years: $12, $9, $7, and $5. Afterward, the company pledges to maintain a constant 4 percent growth rate in dividends forever.

  

Required:

If the required return on the stock is 12 percent, what is the current share price?

Answer 1

The stock price would be composed of two parts. The first part would be equal to the summed Present Value of the variable dividends in the first four years. The second part would be equal to the PV of the Terminal Value of the perpetually growing dividends beginning from Year 5.

Required Return = 12 % and Growth Rate = 4 %

Part 1:

P1 = 12 / 1.12 + 9 / (1.12)^(2) + 7 / (1.12)^(3) + 5 / (1.12)^(4) = $ 26.05 approximately.

Part 2:

Terminal Value of Perpetually Growing Dividends = ( 5 x 1.04) / (0.12 - 0.04) = $ 65

PV of Terminal Value of Perpetually Growing Dividends = P2 = 65 / (1.12)^(4) = $ 41.31

Current Share Price = P1 + P2 = 26.05 + 41.31 = $ 67.36