Question

DC Motors recently paid $1.10 as its annual dividend. Future dividends are projected at $1.06, $1.02, and $1.00 over the next three years, respectively. After that, the dividend is expected to decrease by 2 percent annually. What is one share of this stock worth at a rate of return of 17 percent?

Answer 1

$5.50

Step-by-step explanation:

For computing the value of stock, first we have to determine the dividend at the end of the third year which is shown below:

= last year dividend × (1 + growth rate) ÷ (cost of capital - growth rate)

= $1 × ( 1 - 0.02) ÷ (0.17 +0.02)

= $0.98 ÷ 0.19

= $5.16

The computation of the value of stock is shown below:

Year Dividend Present value factor at 17% Present value

1 $1.06 0.8547 $0.91

2 $1.02 0.7305 $0.75

3 $1 0.6244 $0.62

3 $5.16 0.6244 $3.22

Total present value $5.50

The present value factor is computed below:

= 1 ÷ (1 + rate) ^ years

For Year 1 = 1 ÷ 1.17^1 = 0.8547

For Year 2 = 1 ÷ 1.17^2 = 0.7305

For Year 3 = 1 ÷ 1.17^2 = 0.6244