Question

Leisure Lodge Corporation is expected to pay the following dividends over the next four years: $22.00, $10.00, $8.20 and $2.80. Afterwards, the company pledges to maintain a constant 5 percent growth rate in dividends forever. If the required return on the stock is 16 percent, what is the current share price?

Answer 1

Answer:

The answer is: The current share price is $47.96.

Explanation:

The current share price is equal to the present value of its expected dividend stream discounting at required return rate of 16%.

We have the dividend stream as followed:

Year 1: $22.00; Year 2:$10.00; Year 3: $8.20; Year 4: $2.80; Year 5: $2.80 * 1.05 = $2,94 and will be growing at 5% constantly afterward ( as dividend will be growing at 5% per year from Year 4 afterward).

So, the current share price is equal to:

22/1.16 + 10/1.16^2 + 8.2/1.16^3 + 2.8/1.16^4 + [Present value as at the end of year 4 of growing perpetuity which is dividend payment after year 4] / 1.16^4 = 33.20 + [ 2.94 / ( 16% - 5%) ] /1.16^4 = $47.96.

So, the current share price is $47.96.