Integrated Potato Chips paid a $1.50 per share dividend yesterday. You expect th

Question

Integrated Potato Chips paid a $1.50 per share dividend yesterday. You expect the dividend to grow steadily at a rate of 6% per year. a. What is the expected dividend in each of the next 3 years? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected Dividend Year 1 $ Year 2 Year 3 b. If the discount rate for the stock is 10%, at what price will the stock sell today? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Current price $ c. What is the expected stock price 3 years from now? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Future price $ d. If you buy the stock and plan to hold it for 3 years, what payments will you receive? What is the present value of those payments? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 2 decimal places.) d. If you buy the stock and plan to hold it for 3 years, what payments will you receive? What is the present value of those payments? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 2 decimal places.) Year 1 Year 2 Year 3 Dividend $ $ $ Sale of stock Total cash flow $ $ $ PV of cash flow $ $ $

Explanation / Answer

a) Do=$1.5, present dividend

Dg= Dividend growth rate=6%

Dividend for year 1, D1=Do* (1+Dg)1=1.5*(1+.06)1 =$1.59

Dividend for year 2, D2=Do* (1+Dg)2=1.5*(1+0.06)2 =$1.6854

Dividend for year 3, D3=Do* (1+Dg)3= 1.5*(1.06)3 =$1.7865

b) Discount rate for the stock=10%

Po=Do/(r-g)

Where Po=Price of stock today

Do=Dividend for current period

r=discount rate

g=growth rate of dividend

Po=1.5/(.10-0.06)=1.5/0.04=$37.5

c)Expected stock price 3 years from now, P3=D3/(r-g)

From our calculation in subpart (a),D3=$1.7865

thus,P3=1.79/(0.10-0.06)=1.7865/0.04=$44.6631

Price of the stock in year 3 will be $44.6631=$44.66

d)If we plan to buy the stock and hold it for another 3 years, then the payments will be-

We need to calculate NPV factors first, so the same will be used in calculation of PV

NPV factor=1/(1+r)t

Current year=1

Year 1=1/(1.10)^1=0.9091

Year 2= 1/(1.10)^2=0.8264

Year 3=1/(1.10)^3=0.7513

PV1=CF*NPV factor for year 1=1.59*0.9091=1.4455

PV2=CF*NPV factor for year 2=1.6854*0.8264=1.39289

PV3=CF*NPV factor for year 3=46.4496*0.7513=34.89829

Sum of the present values=1.4455+1.39289+34.89829=37.7366=37.74, which is closely equivalent to the current period stock price.

Total discounted Cash flow=37.74-37.5=0.24

where, 37.5 is the current period stock price

Year1 year 2 year 3 Dividend 1.59 1.6854 1.7865 Stock Price 44.6631 Total Cash flow 1.59 1.6854 1.7865+44.6631=46.4496 PV of cash flow 1.4455 1.39289 34.89829

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