1) IBIS Corporation has had dividends grow from $2.50 per share to $6.00 per sha

Question

1) IBIS Corporation has had dividends grow from $2.50 per share to $6.00 per share over the last 10 years (the $6.00 per share dividend was paid yesterday; that is, D0 = $6.00). This compounded annual growth rate in dividends is expected to continue into the future forever. If the current market price of IBIS’s stock is $45.00 per share, what rate of return do investors expect to receive from buying IBIS stock?

2)Malcolm Manufacturing, Inc. just paid a $2.00 annual dividend (that is, D0 = 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 dividend 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%, what is the current price of the stock?

Explanation / Answer

1.

Find the growth rate

PV = 2.5

FV = 6

N = 10

PV = FV/(1+r)^n

PV - Present value

FV - Future value

r - Interest rate

n - no. of periods

2.5 = 6/(1+r)^10

r = 9.15%

So, the growth rate of dividends = 9.15%

According to dividend-discount model,

P0 = D1/(R-G)

P0 = Current stock price

D1 - Dividend at t =1

R - Required rate

G - Growth rate

45 = 2.5*(1+0.0915)/(R-0.0915)

R = 15.21%

Rate of return = 15.21%

2.

D0 = 2

D1 = 0

D2 = 0

D3 = 5

D4 = 5*1.1 = 5.5

D5 = 5.5*1.1 = 6.05

D6 = 6.05*1.1 = 66

D7 = 66*1.03 = 6.8547

According to dividend-discount model,

P0 = D1/(R-G)

P0 = Current stock price

D1 - Dividend at t =1

R - Required rate

G - Growth rate

P6 = D7/(R-g) = 6.8547/(0.14-0.03) =62.32

To find the present value discount the future dividedns and P6

P0 = 5/(1+0.14)^3 + 5.5/(1+0.14)^4 + 6.05/(1+0.14)^5 + 6.66/(1+0.14)^6 + 62.32/(1+0.14)^6 = 41.20

Current stock price = $41.20

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