SC expects the following dividend stream for the next 5 years and then a sustain
ID: 2720993 • Letter: S
Question
SC expects the following dividend stream for the next 5 years and then a sustainable growth of 6% afterwards. The firm’s last dividend was $2.50. Unfortunately you were unable to purchase the stock in time to receive the current dividend. Your required rate of return is 13%
2016 D0 $1 (1)
2017 D1 $0 (0)
2018 D2 $0 (0)
2019 D3 $2 (2)
2020 D4 $3 (3)
1A. If investors want a required rate of return of 13%, what price would they pay for the firm's stock today? Remember they're selling at ex-dividend.
1B. What price will investors pay for SC's common stock three years from today? That is P3 =? Again, assume that the stock is selling at an ex dividend when value in 2018.
1C. What price will imvestors pay for SC's common stock eight years from today in 2023. That is P8 =? Again, assume that the stock is selling at an ex dividend
PLEASE SHOW WORK THANK YOU!!
Explanation / Answer
a) Present Value of Dividends:
D3 = $2/(1.13)3 = $1.39
D4 = $3/(1.13)4 = $1.84
Terminal Value = [D4*(1+growth rate)] / (Required Return – Growth rate)
=> [$3*(1.06)]/(0.13 – 0.06) = $45.43
Present Value of Terminal value = $45.43/(1.13)4 = $27.86
Price of stock = $1.39 + $1.84 + $27.86 = $31.39
b) Price in P3:
There are still two dividends to be received but the present value will differ. Below are the calculations:
D3 = $2/(1.13) = $1.77
D4 = $3/(1.13)2 = $2.35
Terminal Value = [D4*(1+growth rate)] / (Required Return – Growth rate)
=> [$3*(1.06)]/(0.13 – 0.06) = $45.43
Present Value of Terminal value = $45.43/(1.13)2 = $35.58
Price of stock = $1.77 + $2.35 + $35.58 = $39.70
c) First we need to calculate dividend in 2023. For this, we will take the dividend of 2020 (D4) as base and then grow it by 6% annually.
So, D7 = $3 x (1.06)3 = $3.57
Value of Stock = D7 / (Ke – G) => $3.57/(0.13-0.06) = $51.04
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