Question

The Yubaba Company has so far not paid a dividend on its stock. Investors believe that...

The Yubaba Company has so far not paid a dividend on its stock. Investors believe that the Company won’t pay a dividend next year, but that it will pay dividends starting two years from now. The dividend then is expected to be $0.20 per share. Three years from now the dividend is expected to be $0.50 per share, and four years from now it’s expected to be $0.75 per share. Thereafter the dividend is expected to grow at a constant rate = 4% per year. Investors require a minimum annual rate of return on Yubaba stock = 13%. a) What is your estimate of Yubaba’s stock price four years from now? b) What is your estimate of Yubaba’s stock price today?

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Answer #1
Year Dividend (i) PVF(13%, n) (ii) Present value of dividends (i) x (ii)
2 0.20 0.783 0.1566
3 0.50 0.693 0.3465
4 0.75 0.613 0.4598
Total 0.963

D5 = D4 (1 + g)

where.

D5 = Dividend in 5th year

D4 = Dividend in 4th year

g = Growth rate in dividends

D5 = 0.75 (1 + 0.04)

= 0.75 x 1.04

= $0.78

$0.963 is the present value of dividends expected from the company for first 4 years.

P4 = D5/(Ke - g)

= 0.78/(0.13 - 0.04)

= 0.78/0.09

= $8.67

(a) Hence, 4 years from now, Yubaba stock will be $8.67

(b) Present value of share = Present value of dividends + Present value of share after 4 years

= 0.963 + 8.67 x 0.613

= 0.963 + 5.31

= $6.28

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