Question

Problem 8.20 Jenny Banks is interested in buying the stock of Fervan, Inc., which is increasing its dividends at a constant rate of 8.40 percent. Last year the firm paid a dividend of $2.65. The required rate of return is 17.15 percent. What is the current value of this stock? (Do not round intermediate calculations. Round answer to 2 decimal places, e.g. 15.20.) Current value $ LINK TO TEXT What should be the price of the stock in year 5? (Do not round intermediate calculations. Round answer to 2 decimal places, e.g. 15.20.) Price of stock $

Answer 1

Answer:

a). The current value of this stock=$30.29

b). The price of the stock in year 5=$66.84

Explanation:

a). Current value of stock

Use the expression for calculating the required rate of return to solve for the  current value of stock as follows:

RRR=(EDP/SP)+DGW

where;

RRR=required rate of return

EDP=expected dividend payment

SP=share price

DGW=dividend growth rate

In our case:

RRR=17.15%=17.15/100=0.1715

EDP=$2.65

SP=unknown

DGW=8.4%=8.4/100=0.084

replacing in the original expression;

0.1715=(2.65/SP)+0.084

2.65/SP=0.1715-0.084

2.65/SP=0.0875

SP=2.65/0.0875=30.28571

The share price of the stock=$30.29

The current value of this stock=$30.29

b). Future value of stock

The future value of stock can be expressed as;

Future value={(required rate of return+1)^number of years}×current stock price

where;

required rate of return=17.15%=17.15/100=0.1715

number of years=5

current stock price=$30.29

replacing;

30.29×{(0.1715+1)^5)}

30.29×{1.1715^5}

The price of the stock in year 5=$66.84