19. Sun Medical Inc. is in financial trouble. Today, they announced their future

Question

19. Sun Medical Inc. is in financial trouble. Today, they announced their future dividend plan. They plan to pay $1.00 a year for three years, $1.20 a year for the following two years, and then cease paying dividends. How much is one share of this stock worth to you today if you require a 10 percent rate of return? a. $3.35 b. $3.71 c. $3.87 d. $4.05 e. $5.40

20. The company your parents invested in expects to increase their annual dividend by 40 percent per year for the next two years and by 10 percent for the following year. After that, the company plans to pay $1.00 a share per year. The last dividend they paid was $.40 a share. What should you expect to pay per share if the market rate of return on this stock is 11 percent?

Explanation / Answer

D1 = 1

D2 = 1

D3 = 1

D4 = 1.2

D5 = 1.2

Now we will P0 by discounting future cash flows:

P0 = D1/ (1 + 10%)1 + D2/ (1 + 10%)2 + D3/ (1 + 10%)3 + D4/ (1 + 10%)4 + D5/ (1 + 10%)5

P0 = 1/ (1 + 10%)1 + 1/ (1 + 10%)2 + 1/ (1 + 10%)3 + 1.2/ (1 + 10%)4 + 1.2/ (1 + 10%)5

P0 = 0.91 + 0.83 + 0.75 + 0.82 + 0.75

P0 = 4.05

Part 2

D0 = 0.40

D1 = 0.40 * 1.4

D2 = 0.40 * 1.42

D3 = 0.40 * 1.42  * 1.1

D4 = 1

P3 = 1/ (11%) = 9.09

P0 = 0.40 * 1.4/ (1.11) + 0.40 * 1.42/ (1.11)2 + 0.40 * 1.42  * 1.1/ (1.11)3 + 9.09/ (1.11)3

P0 = 0.50 + 0.64 + 0.63 + 6.65

P0 = 8.42

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