Question

General Importers announced that it will pay a dividend of $3.65 per share one year from today. After that, the company expects a slowdown in its business and will not pay a dividend for the next 4 years. Then, 6 years from today, the company will begin paying an annual dividend of $1.75 forever. The required return is 11.4 percent. What is the price of the stock today

Answer 1

The price of the stock is computed as shown below:

= Dividend in year 1 / (1 + required return)¹ + Dividend in year 2 / (1 + required return)² + Dividend in year 3 / (1 + required return)³ + Dividend in year 4 / (1 + required return)⁴ + Dividend in year 5 / (1 + required return)⁵ + 1 / (1 + required return)⁵ ( Dividend in year 6 / required rate of return ) ]

= $ 3.65 / 1.114 + $ 0 / 1.114² +  $ 0 / 1.114³ +  $ 0 / 1.114⁴ +  $ 0 / 1.114⁵ + 1 / 1.114⁵ [ ( $ 1.75 / 0.114) ]

= $ 3.65 / 1.114 + $ 0 / 1.114² +  $ 0 / 1.114³ +  $ 0 / 1.114⁴ +  $ 0 / 1.114⁵ + $ 15.35087719 / 1.114⁵

= $ 12.22 Approximately

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