BACKGROUND: The following fact pattern pertains to Twin Cities Dairy at Septembe

Question

BACKGROUND: The following fact pattern pertains to Twin Cities Dairy at September 30, 2015:

Current annual dividend per share: $1.50

Next dividend payment date: September 30, 2016

Discount rate: 5%

1. In parallel columns, show the expected future dividends payments for each of the next ten years and the present value of all remaining dividends at September 30, 2026 in each of the following three cases: 1) the annual dividends remains $1.50 per share through September 30, 2025, 2) annual dividends grow by 3% per year through September 30, 2025, and 3) annual dividends grow by 5% per year through September 30, 2025. Use the future value of $1 formula, $1(1+i)n to calculate the annual dividends through September 30, 2025. Assume the present value of all remaining dividends is $30 at September 30, 2026 in all three cases.

2. The dividend discount model estimates a firm’s share price using the present value of the expected future dividends. Assuming a discount rate of 5%, determine the share price of the firm at September 30, 2015 under the three options listed in question #1. (Excel has many built in functions. Use the "NPV" function to solve this question and the following question.)

3. Determine dividend growth rate that is built into the current stock price of $35.11 per share. Once again assume the present value of all remaining dividends at September 30, 2026 is $30.

Explanation / Answer

Ans 1 Discount factor @5% situation 1 PV of dividends situation 1 situation 2 (3% growth) PV of dividends situation 2 situation 3 (5% growth) PV of dividends situation 3 Dividend $ 1 Sep 30 ,2015 1.5 1.500 1.5 1.50 1.5 1.500 0.95238095 Sep 30 ,2016 1.5 1.429 1.545 1.47 1.575 1.500 0.90702948 Sep 30 ,2017 1.5 1.361 1.591 1.44 1.654 1.500 0.8638376 Sep 30 ,2018 1.5 1.296 1.639 1.42 1.736 1.500 0.82270247 Sep 30 ,2019 1.5 1.234 1.688 1.39 1.823 1.500 0.78352617 Sep 30 ,2020 1.5 1.175 1.739 1.36 1.914 1.500 0.7462154 Sep 30 ,2021 1.5 1.119 1.791 1.34 2.010 1.500 0.71068133 Sep 30 ,2022 1.5 1.066 1.845 1.31 2.111 1.500 0.67683936 Sep 30 ,2023 1.5 1.015 1.900 1.29 2.216 1.500 0.64460892 Sep 30 ,2024 1.5 0.967 1.957 1.26 2.327 1.500 0.61391325 Sep 30 ,2025 1.5 0.921 2.016 1.24 2.443 1.500 0.58467929 Sep 30 ,2026 30 17.540 30 17.54 30 17.540 2 Under all the methods the share price on Sep 30 2015 will be discounted value of all future devidend s expected on Sep 30,2016= $30/1.05= $ 28.57 3 As per the given table below at 6.31% dividend growth rate the current share price will be $35.11 situation4 (6.31% growth) PV of dividends situation 4 Year Dividend PV of cash flow Sep 30 ,2015 1.5 1.5 Sep 30 ,2016                 1.59                    1.52 Sep 30 ,2017                 1.70                    1.54 Sep 30 ,2018                 1.80                    1.56 Sep 30 ,2019                 1.92                    1.58 Sep 30 ,2020                 2.04                    1.60 Sep 30 ,2021                 2.17                    1.62 Sep 30 ,2022                 2.30                    1.64 Sep 30 ,2023                 2.45                    1.66 Sep 30 ,2024                 2.60                    1.68 Sep 30 ,2025                 2.77                    1.70 Sep 30 ,2026               30.00                  17.54 Total of PV                  35.11

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