Finance General Cereal common stock dividends have been growing at an annual rat

Question

Finance

General Cereal common stock dividends have been growing at an annual rate of 7percentperyearoverthepast10years.Currentdividendsare$1.70pershare. What is the current value of a share of this stock to an investor who requires a 12 percent rate of return if the following conditions exist?

a. Dividends are expected to continue growing at the historic rate for the foresee- able future. b.

The dividend growth rate is expected to increase to 9 percent per year.

c. The dividend growth rate is expected to decrease to 6.5 percent per year.

Explanation / Answer

Ans:

As per Dividend growth Model,

Market value of Equity(ex-dividend) = Current Dividend(1+ expected continuous dividend growth rate)/(Required Equity return rate or cost - expected continuous dividend growth rate)

Required equity return 12%

Current dividend =$1.70 per share

Expected continuous growth rate 7%

Therefore Market value (ex-dividend)= 1.70(1+7%)/(12%-7%)

= 1.70*0.08/0.05

=$ 2.72 per share(ex-dividend) per share

Required equity return 12%

Current dividend =$1.70 per share

Expected continuous growth rate 9%

Therefore Market value (ex-dividend)= 1.70(1+7%)/(12%-9%)

=1.70*0.08/0.03

=$4.53 (ex-dividend) per share

Required equity return 12%

Current dividend =$1.70 per share

Expected continuous growth decrease rate 6.5%

Therefore Market value (ex-dividend)= 1.70(1+7%)/(12%+6.5%)

=1.7*0.080/0.185

=$0.735 per share (ex-dividend)

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