Question

Business Solutions is expected to pay its first annual dividend of $.84 per share in Year 3. Starting in Year 6, the company plans to increase the dividend by 2 percent per year. What is the value of this stock today, Year 0, at a required return of 14.4 percent?

Answer 1

The value of this stock today, Year 0, at a required return of 14.4 percent is $5.01.

The value of the stock today refers to the current market price or worth of a particular stock as of the present moment.

To calculate the value of the stock today (Year 0) at a required return of 14.4 percent, we can use the dividend price model (DPM).

Solution -

DPS3 = 0.84

DPS4 = 0.84

DPS5= 0.84

DPS6 = DPS5 (1+G)

DPS6= 0.84 (1+0.02)

DPS6 = 0.86

Terminal value at the year end 5:

= DPS6 / Required Rate - Growth Rate

= 0.86 / 0.144 -0.02

= $6.91

The current price of stock will be:

= DPS3 / (1+r)^3 + DPS4 / (1+r)^4 + (DPS5 + TerminalValue)/(1+r)^5

= {0.84 / (1+0.144)^3} + {0.84 / (1+0.144)^4} + {(0.84 + 6.91)/ (1+0.144)^5}

= 5.00670598062

= $5.01

Answer 2

Ans. the value of the stock today is $6.31

Step-by-step explanation:

Hi, we need to bring to present value all the cash flows of this stock, that is bringing to present value the cash flows from year 1 through 6 and the horizon value which is the value in year 6 of the cash flows from 6 and beyond.

The formula to use for the dividends from year 1 - 6 is:

`PresentValue=(Dividend((1+r)^(n)-1) )/(r(1+r)^(n) )`

Where:

r = is the discount rate

n = number of consecutive dividends

And the present value of the horizon value is:

`PV(Horizon)=(Dividend*(1+g))/((r-g)) *(1)/((1+r)^(n) )`

So everything together is:

`Price=(Dividend((1+r)^(n)-1) )/(r(1+r)^(n) )+(Dividend*(1+g))/((r-g)) *(1)/((1+r)^(n) )`

Now, the numbers

`Price=(0.84((1+0.144)^(6)-1) )/(0.144(1+0.144)^(6) )+(0.84*(1+0.02))/((0.144-0.02)) *(1)/((1+0.144)^(6) )=3.23+3.08=6.31`

So based on the future cash flows of this share, its fair price is $6.31

Best of luck.