Question

9. Galloway, Inc. has an odd dividend policy. The company has just paid a dividend of $7 per share and has announced that it will increase the dividend by $2 per share for each of the next 5 years, and then never pay another dividend. How much are you willing to pay per share today to buy this stock if you require a 15 percent return

Answer 1

P0 = $41.7196815 rounded off to $41.72

Step-by-step explanation:

To calculate the price of the stock today, we will use the discounted cashflow model. The formula for price under this model will be the present value of the expected future cash flows. The formula is as follows,

P0 = D1 / (1+r) + D2 / (1+r)^2 + ... + Dn / (1+r)^n

Where,

• D1, D2,...,Dn are the dividends in year 1, years 2 and so on to year n
• r is the required rate of return

P0 = (7+2) / (1+0.15) + (7+2+2) / (1+0.15)^2 + (7+2+2+2) / (1+0.15)^3 +

(7+2+2+2+2) / (1+0.15)^4 + (7+2+2+2+2+2) / (1+0.15)^5

P0 = $41.7196815 rounded off to $41.72