You are considering investing in Mike\'s Cable, an enterprise that will pay a di

Question

You are considering investing in Mike's Cable, an enterprise that will pay a dividend of $3, which will increase by 14 percent every year over the following three years and then grow at an annual rate of 6 percent indefinitely. You expect a 23 percent return on your invested capital. What price would you pay for a share in this company?

You are considering investing in Mike's Cable, an enterprise that will pay a dividend of $3, which will increase by 14 percent every year over the following three years and then grow at an annual rate of 6 percent indefinitely. You expect a 23 percent return on your invested capital. What price would you pay for a share in this company?

Explanation / Answer

Hi,

Please find the answer as follows:

D1 = 3

D2 = 3*(1+.14)^1 = 3.42

D3 = 3*(1+.14)^2 = 3.8988 or 3.90

D4 = 3*(1+.14)^3 = 4.44

P4 = D5/(R-g) = 4.44*(1+.06)/(.23 - .06) = 27.68

Current Price = 3/(1+.23)^1 + 3.42/(1+.23)^2 + 3.90/(1+.23)^3 + 4.44/(1+.23)^4 + 27.68/(1+.23)^4 = 20.825 or 20.83

Answer is 20.825 or 20.83.

Thanks.

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