Question

You own a company that competes with Old World DVD Company (in the previous problem). Instead of selling DVDs, however, your company sells music downloads from a web site. Things are going well now, but you know that it is only a matter of time before someone comes up with a better way to distribute music. Your company just paid a $1.50 per share dividend and you expect to increase the dividend 10 percent next year. However, you then expect your dividend growth rate to begin going down to 5 percent the following year, 2 percent the next year, and to -3 percent per year thereafter. Based upon these estimates, what is the value of your company's stock? Assume the required rate of return is 12 percent

Answer 1

Solution :-

D0 = $1.50

D1 = $1.50 * ( 1 + 0.10 ) = $1.65

D2 = $1.65 * ( 1 + 0.05 ) = $1.7325

D3 = $1.7325 * ( 1 + 0.02 ) = $1.767

Now after 3rd year Growth rate = -3.0%

Now P3 = D3 * ( 1 + g ) / ( ke - g )

P3 = $1.767 * [ 1 + ( - 0.03 ) ] / [ 0.12 - (- 0.03) ]

P3 = $1.767 * 0.97 / 0.15

P3 = $11.4276

Now Value of Company Stock = D1/(1+ke) + D2/(1+ke)2 + (D3+P3)/(1+ke)3

= $1.65/(1+0.12) + $1.7325/(1+0.12)2 + ($1.767+$11.427)/(1+0.12)3

= ( $1.65 * 0.893 ) + ( $1.7325 * 0.797 ) + ( $13.195 * 0.7117 )

= $12.246

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