Over the last twelve months, Eastview Corporation paid a dividend of $1.12 per s
ID: 2793401 • Letter: O
Question
Over the last twelve months, Eastview Corporation paid a dividend of $1.12 per share. This dividend is expected to grow over the next three years at a rate of 25%. It is then expected to grow at a normal, constant rate of 7%. Assume that the required rate of return (also the discount rate) is 12%.
What is the present value of the dividends during the supernormal growth years? What is the price of the stock at the end of the third year?
Select one:
a. $4.20, $35.20
b. $1.40, $46.80
c. $1.40, $37.12
d. $2.40, $41.20
e. $4.20, $46.80
Explanation / Answer
Just paid dividend,D0 = $1.12
Growth rate,g = 25% for next 3 years and thereafter 7% per year forever
Required rate of return,RR = 12%
D1 = D0*(1 + g) = $1.12*(1 + 25%) = $1.4
D2 = $1.4*(1 + 25%) = $1.75
D3 = $1.75*(1 + 25%) = $2.1875
D4 = $2.1875*(1 + 7%) = $2.340625
Present value of dividends during the supernormal growth years = D1*PVIF(RR,1) + D2*PVIF(RR,2) + D3*PVIF(RR,3)
= $1.4*PVIF(12%,1) + $1.75*PVIF(12%,2) + $2.1875*PVIF(12%,3)
= $1.4*0.8929 + $1.75 * 0.7972 + $2.1875 * 0.7118
= $4.2022225
Price of the stock at the end 3rd year,P3 = D4/(RR -g)
P3 = $2.340625 / (12% - 7% )
= $46.8125 Per share
And: e
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