Question

Let’s look at a company that is currently not paying dividends. You predict that in five years the company will pay a dividend for the first time. The dividend will be $0.50 per share. You expect the dividend to grow at an 8% rate per year indefinitely at that time. The required return on companies like this one is 15%. What is the price of the stock today?

Answer 1

$4.08

Step-by-step explanation:

First, find the price of the perpetually growing dividend at year 4;

P4 = D5/ (r-g)

P4 = Stock price at t=4

D5 = Dividend at year 5 = 0.50

r = required return = 15% or 0.15 as a decimal

g = dividend growth rate = 8% or 0.08 as a decimal

P4 = 0.50 / (0.15- 0.08)

= 0.50 / 0.07

P4 = 7.1429

Next, find the present value of P4 today by discounting it at 15% discount rate;

PV = 7.1429 / (1.15^4)

PV = 4.0840

Therefore, this stock is worth $4.08 today