A firm will pay a dividend of $0 one year from today and $5.00 two years from to

Question

A firm will pay a dividend of $0 one year from today and $5.00 two years from today (that is, D_1 = $0 and D_2 = 5.00). Thereafter, the dividend is expected to grow at a constant rate forever. The price of this stock today is $100 and the required rate of return on the stock is 10%. What is the expected constant growth rate of the dividend stream from year 2 to infinity Malcolm Manufacturing, Inc. just paid a $2.00 annual dividend (that is, D_0 = 2.00). There will be no dividend payment for the next two years (i.e., at t = 1 and t = 2). In year three (t = 3), the dividend is expected to be $5.00. The ividend will then grow' at 10% annually for the next 3 years (i.e., at t = 4, t = 5 and t = 6) and thereafter (i.e., beginning at t = 7) dividends will grow' at a rate of 3% annually forever. Assuming a required return of 14%, w hat is the current price of the stock

Explanation / Answer

27

28

where

required return = 10.0% Year Previous year dividend Dividend growth rate Dividend current year Terminal value Total Value Discount factor Discounted value 1 0 0.0% 0 0 1.1 0 2 0 0.0% 5 116.0000085 121.0000085 1.21 100.000007 Long term growth rate= 5.45% Value of stock = Sum of discounted value 100.000007

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