Question

A firm expects to increase its annual dividend by 20 percent per year for the next two years and by 15 percent per year for the following two years. After that, the company plans to pay a constant annual dividend of $3 a share. The last dividend paid was $1 a share. What is the current value of this stock if the required rate of return is 12 percent?

a.$17.71
b.$18.97
c.$20.50
d.$21.08
e.$21.69

Answer 1

The current value of the stock is $17.71.correct option is a.

Step-by-step explanation:

To calculate the current value of the stock, we need to find the present value of all the expected dividends. We can break down the calculation into different time periods and then sum them up.

For the first two years, where the dividend increases by 20 percent annually, we can use the formula P = D1 / (1 + r) + D2 / (1 + r)², where P is the present value, D1 is the dividend in the first year, D2 is the dividend in the second year, and r is the required rate of return.

For the next two years, where the dividend increases by 15 percent annually, we can use the same formula. Finally, for the constant dividend of $3 a share, we can use the formula D / r, where D is the dividend and r is the required rate of return.

Plugging in the values and solving for the present value, we get $17.71 as the current value of the stock.