Question

A firm just paid an annual dividend of $1.40 and increases that dividend by 2 percent each year. How do you find the price if the firm's stock at year 4 if the discount rate is 13 percent?

Answer 1

14.05

Explanation:

We have the following:

Current Dividend = D0 = $ 1.40

g = growth rate = 2%

r = discount rate = 13%

Dividend in Year 5

= D5 = D0 * (1 + g) ^ 5

= $ 1.40 * (1 + 2%) ^ 5

= $ 1.40 * (1.02) ^ 5

Firm Stock Price at the end of year 4 = Dividend in Year 5 / (r - g)

= $ 1.40 * (1.02) ^ 5 / (13% -2%)

= $ 1.40 * (1.02) ^ 5 / (0.13 - 0.02)

Therefore, firm stock at the end of year 4 is

P4 = $ 1.40 * (1.02) ^ 5 / (0.13 - 0.02) = 14.05