Question

Stoneworks, Inc., has an odd dividend policy. The company has just paid a dividend of $6 per share and has announced that it will increase the dividend by $5 per share for each of the next five years, and then never pay another dividend. If you require a return of 15 percent on the company’s stock, how much will you pay for a share today?

Answer 1

$71.64

Step-by-step explanation:

Price of a stock is the present value of all future cash flows receivable from the stock discounted at required rate or return

Present Value factor

= 1 / (1 + r) ^ n

Where,

r = Rate of return = 12% or 0.12

n = Years = 1 to 5

So, PV Factor for year 2 will be

= 1 / (1.12^2)

= 1 / 1.2544

= 0.797194

The following table in the attached file shows the calculations

So, the price of the stock today is $71.64

Answer 2

$65.75

Step-by-step explanation:

Share value can be determined by calculating the present value of all the dividend associated with the share. The Present value can be calculated by discounting the each years dividend using required rate of return.

As $6 Dividend is paid now and it will increase by $5 each year for next five years

Dividend for each year are

First year dividend = $6 + $5 = $11

Second year dividend = $11 + $5 = $16

Third year dividend = $16 + $5 = $21

Forth year dividend = $21 + $5 = $26

Fifth year dividend = $26 + $5 = $31

Present value of each year dividend:

First year dividend = $11 x ( 1 + 15% )^-1 = $9.57

Second year dividend = $16 x ( 1 + 15% )^-2 = $12.10

Third year dividend = $21 x ( 1 + 15% )^-3 = $13.81

Forth year dividend = $26 x ( 1 + 15% )^-4 = $14.86

Fifth year dividend = $31 x ( 1 + 15% )^-5 = $15.41

As we know Sum of present values of all the future dividends is the value of the share,

Value of Share = $9.57 + $12.10 + $13.81 + $14.86 + $15.41 = $65.75