Question

GoGo Inc. will pay dividend of $25 at the end of year 1. Because of the uncertainty of the economic condition, GoGo decides to reduce its dividends by 5% every six years. So dividends will be $25 in years 1 to 6, $23.75 in years 7 to 12, $22.56 in years 13 to 18 and so on. If the discount rate is 8% per year, what is current share price of GoGo?

Answer 1

This sum can be solved using Dividend Discount Model (DDM) which basically states that the current price of a company's share price is sum of all of its future dividend payments discounted to its present value.

The questions states that the company would pay dividend of $25 in year 1 and reduce it by 5% every six years till perpetuity.

This sum can be solved in geometric progression.

The effective discount rate per 5 year period is : i = (1+0.08)⁵ -1 = 46.93%

Growth Rate g = -5% (Decreasing )

Using the formula for Perpetuity A x (1+i)/(i-g)

25 x 1.4693/(0.4693 + 5)

=25 x 2.8293

=$70.73

There for the current share price of GoGo is $70.73