Question

Farmco just paid its annual dividend of $.32 per share. The dividends are expected to grow at 25 percent annually for the next 4 years and then level off to an annual growth rate of 3 percent indefinitely. What is the price of this stock today given a required return of 15 percent?

Answer 1

Answer:

$5.73(Approx).

Explanation:

Given:

= 0.32

Growth rate = 25% = 0.25

Number of year = 4

Growth rate after 4 year = 3% = 0.03

Required rate of return = 15% = 0.15

Computation of divined in 4 year:

$Annual\ dividend\ paid(1+growth\ rate)^n\\\\0.32(1+0.25)^4\\\\0.32(1.25)^4\\\\0.32(2.44140625)\\\\0.78125$

Price of stock after year 4 = [Divined in 4 year × (1 + new growth)] /[Required rate of return - Growth rate after 4 year ]

Price of stock after year 4 = [0.78125 × (1+0.03)] / [0.15 - 0.03]  

Price of stock after year 4 = [0.8046875] / [0.12]  

Price of stock after year 4 = $6.70572917

Present value = Future value / $(1+r)^n$

 Present value = $6.70572917 / $(1.15)^4$

 Present value = $6.70572917 / $(1.16985856)$

$5.73(Approx).