Question

A stock is expected to pay dividends in 5 periods. The first dividend will be $4.80 and subsequent dividends are forecasted to stay constant for the foreseeable future. If the required return on the stock is 17.0%, what is its current value? Your Answer:

Answer 1

In the given question, the stock is expected to pay dividend for only 5 periods and not indefinitely, therefore we cannot use Gordon's Growth Model to value the stock. Now that we have definite receipts of $ 4.80 (for 5 periods each), the current value of stock is the present value of each of these dividend amounts. (Assuming the first dividend is paid at the end of Year 1 and similary other 4 dividends will be paid to us at the end of each subsequent year)

CURRENT VALUE = Present Value of $ 4.80 received each year for 5 years at discount rate of 17%

Current Value = 4.8/1.17+4.8/1.17^2+4.8/1.17^3+4.8/1.17^4+4.8/1.17^5

Current Value = $ 15.3569 i.e approx $ 15.36