Question

Combined Communications is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 23 percent a year for the next 4 years and then decreasing the growth rate to 6 percent per year. The company just paid its annual dividend in the amount of $1.40 per share. What is the current value of one share of this stock if the required rate of return is 8.50 percent? a. $62.77 b. $7710 c. $73.01 d. $58.21 e. $66.50

Answer 1

Answer:

Current Market value of the stock at 8.5% return: 105.88

Explanation:

We will calculate the present value of the dividends:

$\left[\begin{array}{ccc}Year&Cash \: Flow&PV\\1&1.722&1.59\\2&2.12&1.8\\3&2.61&2.04\\4&3.21&2.32\\5&3.40&98.13\\&&105.88\\\\\end{array}\right]$

We will do the following:

each dividends we multiply by the previous, by the grow rate of 23%

D1 1.40 x ( 1 + 23%) = D2 = 1.722

D2 1.722 x ( 1 + 23%) = D3 = 2.12

...

Then after the four years we calculate the gordon model for the infinite series of dividends

$\frac{divends}{return-growth} = Intrinsic \: Value$

3.95/(0.085-0.06) = 158

Then calculate the present of each dividends applying the present value of a lump sum

$\frac{Principal}{(1 + rate)^{time} } = PV$

$\frac{1.722}{(1 + 0.085)^{1} } = PV_{div1}$

PV div1 = 1.59

$\frac{2.12}{(1 + 0.085)^{2} } = PV_{div2}$

PV div2 = 1.8

$\frac{2.61}{(1 + 0.085)^{3} } = PV_{div3}$

PV div3 = 2.04

...

Then we add them and get the present value of the stock