Question

Suppose that Ericsson Corporation just announced that they will commence paying annual dividends next year. The plan is to pay 1.50 SEK, 2.75 SEK, 4.00 SEK and 5.25 SEK per share over the next four years, respectively. After that the company plans on increasing the dividend by 4% annually forever. The required rate of return on this stock is 11%. What should the market price of this stock be? If the stock is selling for 42 SEK in the market

Answer 1

Growth rate after year 4 = 4%

Required rate of return= 11%

Dividend for year 4= 5.25

Present Value of stock at year 4 = Dividend for 4th year*(1+growth rate)/(Required rate-growth rate)

So, P4 = 5.25*(1+4%)/(11%-4%)

=$78

Value of stock shall be Dividend received upto 4 th year and present value of stock at end of 4 th year

Year cash flows P.V.F. = 1/(1+0.11)^year. Present value

1 D1. 1.50. 0.9009009009. 1.351351351

2 D2. 2.75 0.8116224332. 2.231961691

3 D3. 4.00. 0.7311913813 2.924765525

4 D4 5.25 0.6587309741 3.458337614

4 P4 78.00. 0.6587309741 51.38101598

Total 61.34743217

So, stock price is 61.35 SEK