Question

Sawchuck Consulting has been profitable for the last 5 years, but it has never paid a dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's forecast of the future dividend stream, along with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value?

Year	0	1	2	3	4	5	6	7
Growth rate	NA	NA	NA	NA	25%	12.5%	8.00%	8.00%
Dividends	$0.000	$0.000	$0.000	$0.25	$0.31	$0.35	$0.38	$0.41

Use the rounded values of dividends (as given in the table above) for your subsequent calculations.

Select the correct answer.

a. $-8.08

b. $-4.03

c. $40.51

d. $8.11

Answer 1

d. $8.11 ,

	year 1	year 2	year 3	year 4	year 5	year 6	year 7
Dividend	0	0	0.25	0.31	0.35	0.38
Terimal value of year 6						Dividend 7 / (required rate - growth rate at 7 year) =$0.41 / (11%-8%) =13.667
Total cash flow	0	0	0.25	0.31	0.35	14.047
Present value of cash flow	0	0	0.25 * 0.7312 =0.183	0.31*0.6587 =0.204	0.35 * 0.5935 =0.208	14.047 * 0.5346 =7.510

estimated stock's current value = 0.183 + 0.204 + 0.208 + 7.510

   = $8.11