Question

Southern Foods just paid an annual dividend of $2.10 a share. Management estimates the dividend will increase by 11 percent a year for the next four years. After that, the annual dividend growth rate is estimated at 3.5 percent. The required rate of return is 11 percent. What is the value of this stock today?

Answer 1

Value of stock today = $37.3738

Step-by-step explanation:

Provided details we have,

Dividend just given = $2.10

Dividend at end of Year 1 = $2.10 + 11% = $2.331

Dividend at end of Year 2 = $2.331 + 11% = $2.5874

Dividend at end of Year 3 = $2.5874 + 11% = $2.872

Dividend at end of Year 4 = $2.872 + 11% = $3.188

Dividend in 5th year = $3.188 + 3.5% = $3.299

Value of share at end of 4th year =
`(D_5)/(K_e - g)`

=
`(3.299)/(0.11 - 0.035)` = $43.987

Therefore value of share today shall be:

Year Present Value factor @11% Return Present Value

1 0.9009 $2.331 $2.099998

2 0.8116 $2.5874 $2.099934

3 0.7311 $2.872 $2.0997192

4 0.6587 $3.188 $2.0999356

4 0.6587 $43.987 $28.9742

Net Present Value i.e. Value of stock today = $37.3738