Question

Kohl’s just paid an annual dividend of $5 a share. Management estimates the dividend will increase by 5 percent a year for the next three years. After that, the dividend growth rate is estimated at 2 percent. The required rate of return is 10 percent. What is the value of this stock today?

Answer 1

Dividend paid (D0)= $5

Growth till year end 3 (g) = 5%

Growth from 4th year onwards (g1) = 2%

Dividend at year end 1 (D1) = $5*1.05 = $5.25

Dividend at year end 2 (D2)= $5.25*1.05 = $5.5125

Dividend at year end 3 (D3)= $5.5125*1.05 = $5.7881

Dividend at year end 4 (D4)= $5.7881*1.02 = $5.9039

Required rate of return (Re) = 10%

Price at the end of year (P3) = D4/ (Re-g1)
= $5.9039/ (0.10- 0.02)
= $5.9039/ 0.08
= $73.80

Price today (P0) = D1/ (Re-g)
= $5.25/ (0.10-0.05)
= $5.25/ 0.05
= $105