Question

Microsoft presently pays no dividend. You anticipate Microsoft will pay an annual dividend of $0.60 per share two years from today and you expect dividends to grow by 4% per year thereafter. IF Microsoft's equity cost of capital is 12%, then the value of a share of Microosfoft today is:

(A) $6.70
(B) $6.90
(C) $5.00
(D) $6.25

Answer 1

(A) $6.70

Step-by-step explanation:

Find dividends per year;

D1=0

D2=0.60

D3=D2(1+g); 0.60(1+0.04) = 0.624

discount rate = 12%

Next, find the PV of each dividend at t=0;

PV of D2 = 0.60 / (1.12) = 0.5357

PV of D3 onwards =
`(0.624 / (0.12-0.04))/(1.12^(2) )`

PV of D3 = 7.8 / (1.12^2) = 6.2181

Then sum up these PVs to find the current value of stock;

Value = 0.5357 + 6.2181

Value = 6.7538

The closest value would be A.) 6.70