Question

announced today that it will begin paying annual dividends next year. The first dividend will be $0.10 a share. The following dividends will be $0.15, $0.20, $0.50, and $0.60 a share annually for the following 4 years, respectively. After that, dividends are projected to increase by 5 percent per year. How much are you willing to pay to buy one share of this stock today if your desired rate of return is 9.5 percent

Answer 1

The maximum that should be paid for the stock today is $9.99

Step-by-step explanation:

The price of the stock today can be calculated using the dividend discount model or DDM which values a stock based on the present value of the expected future dividends of the stock. The price of the stock today is,

P0 = 0.10 / (1+0.095) + 0.15 / (1+0.095)^2 + 0.20 / (1+0.095)^3 +

0.50 / (1+0.095)^4 + 0.60 / (1+0.095)^5 + [ (0.60 * (1+0.05) / (0.095 - 0.05)) / (1+0.095)^5 ]

P0 = $9.99