Question

# XYZ Company announced today that it will begin paying annual dividends next year. The first dividend...

XYZ Company announced today that it will begin paying annual dividends next year. The first dividend will be \$0.1 a share. The following dividends will be \$0.1, \$0.2, \$0.3, and \$0.4 a share annually for the following 4 years, respectively. After that, dividends are projected to increase by 2 percent per year. How much are you willing to pay to buy one share of this stock today if your desired rate of return is 8 percent?

#### Homework Answers

Answer #1

Year 1 dividend = 0.1

Year 2 dividend = 0.1

Year 3 dividend = 0.2

Year 4 dividend = 0.3

Year 5 dividend = 0.4

Year 6 dividend = 0.4 (1 + 2%) = 0.408

Value at year 5 = D6 / required rate - growth rate

Value at year 5 = 0.408 / 0.08 - 0.02

Value at year 5 = 0.408 / 0.06

Value at year 5 = 6.8

Price = Present value of cash flows

Price = 0.1 / (1 + 0.08)^1 + 0.1 / (1 + 0.08)^2 + 0.2 / (1 + 0.08)^3 + 0.3 / (1 + 0.08)^4 + 0.4 / (1 + 0.08)^5 + 6.8 / (1 + 0.08)^5

Price = \$5.46

You are willin to pay \$5.46

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