The Yubaba Company has so far not paid a dividend on its stock. Investors believ

Question

The Yubaba Company has so far not paid a dividend on its stock. Investors believe that the Company won’t pay a dividend next year, but that it will pay dividends starting two years from now. The dividend then is expected to be $0.20 per share. Three years from now the dividend is expected to be $0.50 per share, and four years from now it’s expected to be $0.75 per share. Thereafter the dividend is expected to grow at a constant rate = 4% per year. Investors require a minimum annual rate of return on Yubaba stock = 13%.

a) What is your estimate of Yubaba’s stock price four years from now?

b) What is your estimate of Yubaba’s stock price today?

Explanation / Answer

Requirement a:

Estimation of Stock Price foue years from now:

Dividend in fourth year = D = $0.75

Growth Rate = g = 4%

Annual Rate of Return = Ke = 13%

Stock Price four years from now = (D(1+g)) / Ke

= ($0.75 (1+0.04)) / 13%

= 0.78 / 13%

= 6

Estimated Stock Price four years from today = $6

Requirement b:

Estimation of Stock price today:

Estimated Stock Price today = $4.64

Year Cash Flow PVIF (13%) PV of Cash Flow 2 $0.20 0.7831 $0.15662 3 $0.50 0.6930 $0.3465 4 $6.75 ($0.75 + $6) 0.6133 $4.139775 $4.642895

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