5. Company C will pay an annual dividend of $1.46 a share next year with future

Question

5. Company C will pay an annual dividend of $1.46 a share next year with future dividends increasing by 4.2 percent annually. What is the required rate of return on the stock if the stock is currently selling for $42.10 a share?

6. Company D is growing quickly. Dividends are expected to grow at a 19 percent rate for the next 3 years, with the growth rate falling off to a constant 8 percent thereafter. The required return is 12 percent and the company just paid a $3.80 annual dividend. What is the current share price?

7. Company E just paid a dividend of $1.56 per share on its stock. The dividends are expected to grow at a constant rate of 6 percent per year, indefinitely. What will the price of this stock be in 7 years if investors require a 15 percent rate of return?

Explanation / Answer

5.

According to dividend-discount model,

P0 = D1/(R-G)

P0 = Current stock price

D1 - Dividend at t =1

R - Required rate

G - Growth rate

42.10 = 1.46/(R-0.042)

R = 0.0767 = 7.67%

6.

D0 = 3.80

D1 = 3.80*1.19 = 4.522

D2 = 4.522*1.19 = 5.3812

D3 = 5.3812 * 1.19 = 6.4036

D4 = 6.4036*1.08 = 6.9159

P3 = D4/(R-g) = 6.9159/(0.12-0.08) = 172.90

P0 = 4.522/(1+0.12)^1 + 5.3812/(1+0.12)^2 + 6.4036/(1+0.12)^3 + 172.90/(1+0.12)^3 = 135.95

Stock price = $135.95

7.

D0 = 1.56

D1 = 1.56*(1+0.06)^1

D8 = 1.56*(1+0.06)^8 = 2.4864

P7 = D8/(R-g) = 2.4864/(0.15-0.06) = 27.63

Price in 7 years = $27.63

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