Lohn Corporation is expected to pay the following dividends over the next four y

Question

Lohn Corporation is expected to pay the following dividends over the next four years: $16, $12, $11, and $7.50. Afterward, the company pledges to maintain a constant 6 percent growth rate in dividends forever. If the required return on the stock is 16 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Lohn Corporation is expected to pay the following dividends over the next four years: $16, $12, $11, and $7.50. Afterward, the company pledges to maintain a constant 6 percent growth rate in dividends forever. If the required return on the stock is 16 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Explanation / Answer

The current share price can be calculated by discounting the dividends.

We know the dividends for 4 years, from 5th year onwards, dividend grows at a constant growth rate. This continuous dividend value can be calculated by Gordon growth model which is

Share Price (p0)= Dividend At Year 0 (d0) * growth rate(1+g)/( cost of equity – growth rate)

D4 = 7.50 , g = 6%; cost of stock (r) = 16%

So P4 = D4 *(1+g)/ (r-g)

P4 = 7.50 *1.06 /(0.16-0.06) = $79.50

Now the cash flow stream is

T = 1 : $ 16 ; T = 2 : $ 12 ; T = 3 : $ 11 ; T = 4 : $ 7.5 + 79.5 = $87

Now we need to discount this stream @ 16%

So, Share price = 16/1.16 + 12/(1.16)2 + 11/(1.16)3 + 87/(1.16)4

Share price = $ 77.81

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