A) The Bell Weather Co. is a new firm in a rapidly growing industry. The company

Question

A) The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 16 percent a year for the next 4 years and then decreasing the growth rate to 6 percent per year. The company just paid its annual dividend in the amount of $1.60 per share. What is the current value of one share of this stock if the required rate of return is 7.10 percent? B) The Red Bud Co. pays a constant dividend of $1.80 a share. The company announced today that it will continue to do this for another 2 years after which time they will discontinue paying dividends permanently. What is one share of this stock worth today if the required rate of return is 7.4 percent? C) Railway Cabooses just paid its annual dividend of $2.50 per share. The company has been reducing the dividends by 11.7 percent each year. How much are you willing to pay today to purchase stock in this company if your required rate of return is 13 percent?

Explanation / Answer

A)

In case of divided growing constantly, Price of share = Dividend(1+growth rate)/ (Required return – Growth rate)

Price of share at the end of year 4 = Dividend for year 4(1+growth rate) / (Required return – Growth rate)

Dividend for year 4 = $1.60 * 1.164 = $1.60*1.8106 = $2.90

Price of share at end of year 4 = ($2.90*1.06)/(0.0710-0.06) = $279.45

Current price per share = ($1.6*1.16)/1.0710 + ($1.6*1.162)/1.07102 + ($1.6*1.163)/1.07103 + ($1.6*1.164)/1.07104 + $279.45/1.07104 = $377.47

B)

Current value of share = $1.80/1.074 + $1.80/1.0742 = $3.24

C)

Growth rate = -11.7%

Current price of share = $2.50*(1-0.117) / (0.13 + 0.117) = $8.94

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