Beachmaster Suntan Oil’s dividend is expected to grow at a 20% rate each of the

Question

Beachmaster Suntan Oil’s dividend is expected to grow at a 20% rate each of the next 2 years. After that, dividend growth is expected to normalize at about 8.5% annually. Beachmaster just paid a $2.25 annual dividend per share. The require rate of the return of the stock is 10%.

1.Draw the time line of the stock’s CFs?

2.What is the forecasted dividend for each of the next 2 years (D1 and D2)?

3.What is the forecasted dividend 3 years from now?

4.At what price do you foresee Beachmaster’s stock selling 2 years from now (what is your forecasted P2)?

5.What are the present values of D1, D2, and P2?

6.What is your estimated stock price today?

Explanation / Answer

2.Calculation of Forecasted dividend for each of the next 2 years :

                               current dividend D0 =$2.25

                  Growth rate for next 2 years = 20%

                             1st year dividend D1 = $2.7 ($2.25+20%)

                     2nd year dividend D2= $3.24 ($2.7+20%)

3) Calculation of forecasted dividend 3 years from now :

2 nd year dividend D2=$3.24

   Growth rate from 3rd year = 8.5%     

                           3 rd year dividend D3=$3.5154 ($3.24+8.5%)

4) Calculation of stock price after 2 years :

                           Dividend after 2 years D2= $3.24

                          Required rate of return     = 10%

                         Growth rate   = 8.5%

                          Stock price after 2years   = $234.36 ($3.24(1+0.085)/0.10 - 0.085)

5) Calculation of present values of D1,D2,P2 :

6) Calculation of Estimated price today :

                Estimated price today is nothing but total of above present values = $198.71

1) Time line :

            Sorry for inconvenience i couldn't able to upload the image of time line which i was drawn i have tried but i failed ,how ever i could explain how to draw time line diagram easily for this question.

         Here time line diagram is nothing but cash flow diagram which reflects your cash outflows and inflows periodically. Just draw a straight line with period number sequentially and start with down arrow at period 1 because it shows a negative cash flow that is stock price you should pay today to purchase the stock and then draw up arrows from your straight line which represents your cash inflows in the form of dividends,But the main thing is Those amounts should not be discounted values,they should be normal yearly cash flows and ultimately stop with the period when you would like to sell the stock. Here P0 starts with negative cash flow of $198.71 which represents current stock price you should pay to get a stock in your portfolio and that line should be drawn to downwards from straight line and the p1,p2,p3 with dividend receipts amount given 2.7,3.24 etc and this should be uparrows from staright line.

Particulars Cash flow PV factor@10% Present values D1 2.70 0.909 2.4543 D2 3.24 0.826 2.6762 P2 234.36 0.826 193.58

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