Question

A company is expecting its sales to decline and has announced that it will be reducing its annual dividend by 7.00% a year for the next two years. After that, it will maintain a constant dividend of $1.00 a share. Just recently, the company paid a dividend of $3.00 per share. What is this stock worth if you require a 11.00% rate of return?

	$11.70
	$12.00
	$12.30
	$12.60
	$12.90

Answer 1

Price = [ D1 / ( 1 + r ) ] + [ D2 / ( 1 + r )² ] + [ D3 / ( 1 + r )² * r ]

       = [ D0 * (100 - 7)% / ( 1 + r ) ] + [ D1 * (100 - 7)% / ( 1 + r )² ] + [ 1 / ( 1 + r )² * r ]   [ since D3 = 1 ]

         = [ 3 * 93% / ( 1 + 0.11 ) ] + [ (3 * 93%) * 93% / ( 1 + 0.11 )² ] + [ 1 / ( 1 + 0.11 )² * 0.11 ]

         = 2.5135 + 2.1059 + 7.3784

         = $ 12 Answer

Option B is correct.