Question

5. You are considering to buy stocks of a new firm NNN. The firm just paid dividends $1 per share. The dividend payment is expected to increase by 25% in the first two years, 10% in the following two years, afterwards 3% forever. Your required return is 10%. What is the maximum price you are willing to pay? What is the value of D1? What is the value of D4? In which year, growth rate becomes constant? (fill with integer, for example, in year 3, fill "3") In the first step, you can compute price from constant growth rate at which period? (fill with integer, for example, can compute price in year 3, fill "3") What is the maximum price you are willing to pay? (Answer format: keep 2 digits after decimal point and no dollar sign, e.g., 1.456 >> 1.46)

Answer 1

To calculate the maximum price you are willing to pay for the stocks, you need to calculate the present value of all the future dividends. The dividend payment is expected to increase by 25% in the first two years, 10% in the following two years, and 3% thereafter. Your required return is 10%.

Step-by-step explanation:

To calculate the maximum price you are willing to pay for the stocks, you need to calculate the present value of all the future dividends. The dividend payment is expected to increase by 25% in the first two years, 10% in the following two years, and 3% thereafter. Your required return is 10%.

First, calculate the value of the first dividend (D1). Since the dividend payment is $1 and the growth rate is 25%, the value of D1 is $1.25.

Next, calculate the value of the dividend in year 4 (D4). Since the dividend payment is $1.25 the growth rate for the first two years is 25%, and for the following two years is 10%, the growth rate becomes constant in year 4. Therefore, D4 is $1.25 * (1 + 3%)^2 * (1 + 10%)^2.

To find the year in which the growth rate becomes constant, you need to find the year in which the growth rate changes from 10% to 3%. This occurs in year 4.

To calculate the maximum price you are willing to pay, you need to calculate the present value of all the future dividends. You can do this by using the formula for the present value of growing perpetuity: PV = D1 / (r - g), where PV is the present value, D1 is the first dividend, r is the required return, and g is the growth rate. Plug in the values to calculate the maximum price you are willing to pay.