Question

Problem 7-28 Nonconstant Growth (LO2) Planned Obsolescence has a product that will be in vogue for 3 years, at which point the firm will close up shop and liquidate the assets. As a result, forecast dividends are DIV1 = $12.00, DIV 2 = $12.50, and DIV 3 = $28.00. What is the stock price if the discount rate is 10%? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Stock price

Answer 1

Answer:

Po = D1        +     D2    +         D3

       (1 + Ke)     (1 + Ke)2   (1 + Ke)3                                                                                                                                          

Po = $12 +   $12.50 +      $28

     (1 + 0.1)    (1 + 0.1)2   (1 + 0.1)3

Po = $12 + $12.50 + $28

        1.1       (1.1)2        (1.1)3

Po = $10.91 + $10.33 + $21.04

Po = $42.28  

                                                                                   

Explanation:                                                                      

The current stock price is a function of future dividends capitalised at the cost of capital of the company of 10% for a period of 3 years.