Question

ECC Corp. will pay annual dividends of $20 per share for the next 5 years. At the end of year 6, ECC will increase the dividends by 1% per year forever. The required rate of return on this stock is 6%. What is the price of the stock today?

Answer 1

$386.14

Step-by-step explanation:

The computation of the price of the stock today is as follows;

But before that following calculations need to be done

Year 6 dividend = $20 × (1 + 1%)

= $20 × (1 + 0.01)

= 20.2

Now

Value at year 5 = Dividend at year 6 ÷ (required rate - growth rate )

= $20.2 ÷ (0.06 - 0.01 )

= $20.2 ÷ 0.05

= 404

Now

Price of stock = Annuity × [1 - 1 ÷ (1 + r)^n] ÷ r + FV ÷ (1 + r)^n

= $20 × [1 - 1 ÷ (1 + 0.06)^5] ÷ 0.06 + 404 ÷ (1 + 0.06)^5

= $20 × [1 - 0.747258] ÷ 0.06 + 301.892302

= $20 × 4.212367 + 301.892302

= $386.14