Question

The earnings and dividends of Nsuala Computer Co. are expected to grow at an annual rate of 15 percent over the next 4 years and then slow to a constant growth rate of 8 percent per year. Nebula currently pays a dividend of $0.50 per share. What is the value of Nsuala stock to an investor who requires a 14 percent rate of return?

Answer 1

Answer:

$11.36

Explanation:

Data provided in the question:

Annual growth rate for 4 years = 15% = 0.15

Growth rate after 4 years = 8% = 0.08

Current dividend paid, D0 = $0.50 per share

Required rate of return = 14% = 0.14

Now,

Dividend paid for the next year = Current dividend × ( 1 + growth rate )

Thus,

Do = $0.50

D1 = $0.50 × ( 1 + 0.15 ) = $0.575

D2 = $0.575 × ( 1 + 0.15 ) = $0.661

D3 = $0.661  × ( 1 + 0.15 ) = 0.7604

D4 = $0.7604  × ( 1 + 0.15 ) = $0.8745

D5 = $0.8745  × ( 1 + 0.08 )  = $0.9444

Therefore,

Current Price = [ ₀⁴∑ (Dividend ÷ (1 + r )ⁿ) ] + [ D5 ÷ ( r - g ) ] ÷ (1 + r)⁴

Here,

n is the year

r is the required rate of return

thus,

= $0.575 ÷ (1 + 0.14) + $0.661 ÷ (1.14)² + $0.7604 ÷ (1.14)³ +$0.8745 ÷ (1.14)⁴ + [ ($0.9444 ÷ (0.14 - 0.08)) ] ÷ 1.14⁴

= $11.36