1. General Cereal common stock dividends have been growing atan annual rate of 7

ID: 2770608 • Letter: 1

Question

1. General Cereal common stock dividends have been growing atan annual rate

of 7 percent peryear over the past 10 years. Current dividend(D0) is $1.70per

share. What is thecurrent value of a share of this stock to an investorwho

requires a 12percent rate of return if the following conditionsexist?

a. Dividends are expected to continue growing at the historicrate for the

foreseeablefuture.

b. The dividend growth rate is expected toincreaseto 9 percent peryear.

c. The dividend growth rate is expected todecreaseto 6.5 percent peryear.

(a) Dividends are expected to continue growingat the historic rate for the foreseeable future:

Dividend growth rate (g) = 7%

Number of years = 10 years

Current Dividend (D0) = $1.70per share

Required Return (R) = 12%

P0 = D1 / (R-g)

D1 = $1.70 * (1+0.07) / (0.12 – 0.07)

= $1.819 / 0.05

P0 = $36.38

(b) The dividend growth rate is expected to increaseto 9% per year:

Dividend growth rate (g) = 9%

P0 = D1 / (R-g)

D1 = $1.70 * (1+0.09) / (0.12 – 0.09)

= $1.853 / 0.03

P0 = $61.76

( c) The Dividend growth rate is expected todecrease to 6.5% per year:

Dividend growth rate (g) = -6.5%

P0 = D1 / (R-g)

D1 = $1.70 * [1+ (-0.065)] / [0.12- (-0.065)]

= $1.5895 / 0.185

P0 = $8.59

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