Storico Co. just paid a dividend of $1.65 per share. The company will increase i

Question

Storico Co. just paid a dividend of $1.65 per share. The company will increase its dividend by 24 percent next year and will then reduce its dividend growth rate by 6 percentage points per year unti it reaches the industry average of 6 percent dividend growth, after which the company will keep a constant growth rate forever. If the stock price is $42.54, what required return must investors be demanding on Storico stock? Hint Set up the valuation formula with all the relevant cash flows, and use trial and error to find the unknown rate of return.) (Do not round intermediate calculations and round your final answer to f decimal place. (e.g. 32.16)) Required return

Explanation / Answer

Using trail and error method, at a rate of 11.6% calculating the price bond the bond.

Step 1:

Calculation of price of bond at the time period where dividends will grow at a constant rate i.e 6%

for the next year dividend grow at 24%, Year 2 at 18%, year 3 at 12% from year 4 onwards at 6%. Need to calculate value of share at year 3.

At year 3 share price= Dividend at year 4/ (required rate- growth)= 2.8662/(11.6%-6%)= 51.1827

Calculation of present value of dividend and market price of year 3 to present date:

Hence at 11.6% stock price equals 42.54

Workings:

Dividend calucations:

Y1 Y2 Y3 Dividend 2.046 2.41428 2.703994 Market price 51.18274 53.88673 Discount factor@ 11.6% 0.896057 0.802919 0.719461 1.833333 1.938471 38.76941 Total present value 42.54

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