Question

Microsoft presently pays no dividend. You anticipate Microsoft will pay an annual dividend of $0.60 per share two years from today and you expect dividends to grow by 4% per year thereafter. IF Microsoft's equity cost of capital is 12%, then the value of a share of Microosfoft today is:

Answer 1

Answer:

The value of this stock today should be $6.22

Explanation:

The company will start paying dividends 2 years from today that is at t=2. The dividends received 2 years from today can be denoted as D2. The constant growth model of DDM will be used to calculate the price of this stock at t=2 as the growth rate in dividends is constant forever.

The price at t=2 will then be discounted back to its present value today to calculate the price of this stock today.

The price of this stock at t=2 will be,

P2 = D2 * (1+g) / (r - g)

P2 = 0.6 * (1+0.04)  /  (0.12 - 0.04)

P2 = $7.8

The value of this stock today should be,

P0 = 7.8 / (1+0.12)^2

P0 = $6.218 ROUNDED OFF TO $6.22

Answer 2

Answer:

Price of share = $ 0.6696

Explanation:

According to the dividend valuation model , the current price of a stock is the present value of the expected future dividends discounted at the required rate of return

This principle can be applied as follows:

Year 2  0.60× 1.12^(-2) = $0.04783

PV of year of year 3 onward

This will  done in two steps:

Step 1

Calculate the PV of dividend in year 2 terms

= 0.60× 1.04 /(0.12-0.04) = $0.78

Step 2

Re-discount the PV (in year 2) to year 0

0.78 × 1.12 ^(-2) = 0.621811224

Price of share

=0.04783 +0.621811

=$ 0.6696