PROBLEM # 1 ABC Company currently pays a dividend of $2.85 per share, D 0 =2.85

Question

PROBLEM # 1

ABC Company currently pays a dividend of $2.85 per share, D0=2.85 It is estimated that the company’s dividend will grow at a rate of 25 percent per year for the next 3 years, then the dividend will grow at a constant rate of 9 percent per year thereafter. The market rate of return is 10 percent. What would you estimate is the stock’s current price?

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PROBLEM # 2

FIFA Company currently pays a dividend of $1.80 per share, D0=1.80 It is estimated that the company’s dividend will grow at a rate of 30 percent per year for the next 2 years, then the dividend will grow at a constant rate of 7 percent per year thereafter. The market rate of return is 12 percent. What would you estimate is the stock’s current price?

Explanation / Answer

Price of stock = Present Value of dividend stream + present value of terminal dividend value

D1 = 2.85*1.25 = 3.5625

D2 = 2.85 * 1.25^2 = 4.453

D3 = 2.85 * 1.25^3 = 5.566

D4 = 5.5666 * 1.09 = 6.067

Terminal value D3 = 6.067 / ( 10% - 9%) = 606.70

Stock Price= 3.5625/1.1 + 4.453/1.1^2 + 5.566/1.1^3 + 606.7/1.1^3 = 466.92

PROBLEM 2

D1 = 1.8 * 1.3 = 2.34

D2 = 1.8 * 1.3^2 = 3.042

D3 = 30.42 * 1.07 = 3.255

Terminal value D2 = 3.255 / ( 12% - 7%) = 65.10

Stock Price = 2.34 / (1.12) + 3.042/(1.12)^2 + 65.10/( 1.12)^2 = 56.411

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