Question

CBiz Personnel just paid a $7.26 per share annual dividend with the stated intention of increasing its dividend by 2.5% annually. You would like to purchase stock in this company but realize that you will not have the funds to do so for another 3 years. If you require a 15% annual rate of return, how much will you be willing to pay per share for the stock when you can afford to make this investment?

Please show all calculations. Thank you

Answer 1

Price of a constant growth stock

= D1 / (Re – G)

Where,

D1 = Expected dividend next year

Re = Required rate of return = 15% or 0.15

G = Growth rate = 2.5% or 0.025

As the investor will be able to purchase the stock in 3 years, we have to calculate expected price of the stock at the end of third year

Expected dividend in 4^th year (as the price will be calculated at the end of year 3 which will require expected dividend in 4^th year)

= D0 x (1 + r) ^ n

= $7.26 x 1.025^4

= $ 8.01

Price of the stock at the end of year 3

= $8.01 / (0.15 – 0.025)

= $ 64.08