Question

Far Side Corporation is expected to pay the following dividends over the next four years: $11, $8, $5, and $2.

Afterward, the company pledges to maintain a constant growth rate in dividends forever. If the required rate of return on the stock is 12 percent, what is the current share price?

Answer 1

Current price of share=40.1

Step-by-step explanation:

The current value of a share is the present value of future dividends in perpetuity, discounted at the cost of equity (i.e. the return required by the providers of equity capital).

Based on the above discussion the share price shall be calculated as:

Present value of year 1 dividend=11(1+12%)^-1=9.82

Present value of year 2 dividend=8(1+12%)^-2=6.38

Present value of year 1 dividend=5(1+12%)^-3=3.56

Present value of year 1 dividend=2(1+12%)^-4=1.27

Present value of dividend after year 4=(d(1+g)/ke-g)(1+ke)^-4=(2(1+5%)/12%-5%)(1+12%)^-4=19.07

(Assuming that dividend growth rate is 5% after year 4)

Current price of share=40.1

(9.82+6.38+3.56+1.27+19.07)