Question

Bayou Okra Farms just paid a dividend of $3.85 on its stock. The growth rate in dividends is expected to be a constant 4 percent per year indefinitely. Investors require a return of 12 percent for the first three years, a return of 10 percent for the next three years, and a return of 8 percent thereafter. What is the current share price?

Answer 1

The answer is "$86.44".

Step-by-step explanation:

The more recent dividends paid
`= \$ \ 3.85`

Level of growth
`= 4 \%`

Required returns level for a first 3 years = 12
`\%`

Required returns rate for year 3 to year 6 = 10
`\%`

Required returns level after years 6= 8
`\%`

Formula:

`\text{Value of stock}= \frac{ \text{Last Dividend} * (1+ Growth \ rate)}{\text{(Required rate of return - Growth Rate)}}`

Divididend payment for year O to year 6 is calculated below:

Year
`0 \ \ \ \ \ \ \ \ \ \ \ 1 \ \ \ \ \ \ \ \ \ \ \ 2 \ \ \ \ \ \ \ \ \ \ \ 3 \ \ \ \ \ \ \ \ \ \ \ 4 \ \ \ \ \ \ \ \ \ \ \ 5 \ \ \ \ \ \ \ \ \ \ \ 6`

Rate of return needed 12
`\%` 12
`\%` 12
`\%` 10
`\%` 10
`\%` 10
`\%`

Collection of dividend
`\$ \ 3.85 \ \ \ \ \ \ 4.00 \ \ \ \ \ \ 4.16 \ \ \ \ \ \ 4.33 \ \ \ \ \ \ 4.50 \ \ \ \ \ \ 4.68 \ \ \ \ \ \ 4.87` Benefit of terminal 126.6584

Dividend purchase price 3.58 3.32 3.08 3.08 2.91 2.75 Terminal value at year-end 3 95.16

Present dividend value 67.73

Value of Stock $86.44