Question

Honda will pay $4, $5, $6 in the following years. After that the dividends will grow at an annual rate of 12% for the next 10 years leading into growing perpetuity at an annual growth rate of 3%. Assume that investors require a 14% return. What is the maximum price you will pay today? (Details pls.)

Answer 1

Expected Dividends:

D1 = $ 4, D2 = $ 5 and D3 = $ 6, Beyond Year 3 and up to Year 13 (for a total of 10 years), the dividends will grow at a constant rate of 10%, thereby forming a growing annuity, Beyond Year 13 dividends will grow in perpetuity at 3 %

Required Rate of Return = 14 %

D4 = D3 x 1.1 = 6 x 1.1 = $ 6.6 and D10 = D3 x (1,1)^(10) = 6 x (1.1)^(10) = $ 15.56245

D11 = D10 x 1.03 = 15.56245 x 1.03 = $ 16.029328

Therefore, Maximum Stock Price Payable = Total Present Value of All Dividends = 4/1.14 + 5/ (1.14)^(2) + 6 / (1.14)^(3) + 6.6 x [1/(0.14- 0.1)]  x [1-{(1.1) / (1.14)}^(10)] x [1/(1.14)^(3)] + [16.029328 / (0.14 - 0.1)] x [1/(1.14)^(10)] = $ 84.1638 ~ $ 84.16