Storico Co. just paid a dividend of $1.80 per share. The company will increase i

ID: 2651856 • Letter: S

Question

Storico Co. just paid a dividend of $1.80 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the required return on Storico stock is 13 percent, what will a share of stock sell for today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Explanation / Answer

To calculate the price of the stock today, we will have to determine the present value of all the future dividends and stock price at the end of the year after which the dividend growth rate becomes constant. The stock price will be calculated with the use of following formula:

Current Stock Price = D1/(1+Required Return)^1 + D2/(1+Required Return)^2 + D3/(1+Required Return)^3 + P3/(1+Required Return)

We have taken P3 becausem after this the dividend growth rate will become constant.

______________

Here,

D1 = 1.80*(1+20%)

D2 = 1.80*(1+20%)*(1+15%)

D3 = 1.80*(1+20%)*(1+15%)*(1+10%)

P3 = 1.80*(1+20%)*(1+15%)*(1+10%)*(1+5%)/(13% - 5%) [price at the end of Year 3]

Using these values in the above formula, we get,

Current Stock Price (P0) = 1.80*(1+20%)/(1+13%)^1 + 1.80*(1+20%)*(1+15%)/(1+13%)^2 + 1.80*(1+20%)*(1+15%)*(1+10%)/(1+13%)^3 + 1.80*(1+20%)*(1+15%)*(1+10%)*(1+5%)/(13% - 5%)*(1+13%)^3 = $30.61 (answer)

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Storico Co. just paid a dividend of $1.80 per share. The company will increase i

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