Question

is preparing to pay its first dividends. It is going to pay $1.00, $2.50, and $5.00 a share over the next three years, respectively. After that, the company has stated that the annual dividend will be $1.25 per share indefinitely. What is this stock worth to you per share if you demand a 7% rate of return?

Answer 1

Answer:

The answer is: share price should be $21.78.

Explanation:

The share price equals to the present value of the annual dividend stream earned from the share paid at the end of each year; discounting at the required rate of return 7%.

We have dividend stream given as follow: Y1: $1; Y2: $2.5; Y3: $5; Y4 forward: fixed at $1.25.

So share price = 1/1.07 + 2.5/1.07^2 + 5/1.07^3 + [ ( 1.25/0.07) / 1.07^3 ] = 0.94 + 2.18 + 4.08 + 14.58 = $21.78.

So, the answer is share price should be $21.78.

Answer 2

Answer:

$21.78

Explanation:

This can be calculated as follows:

Present value (PV) of year 1 dividend = $1 × [(1 ÷ (1.07)^1] = $0.94

PV of year 2 dividend = $2.50 × [(1 ÷ (1.07)^2] = $2.18

PV of year 3 dividend = $5.00 × [(1 ÷ (1.07)^3] = $4.08

PV of $1.25 indefinite dividend = (1.25 ÷ 0.07) ÷ 1.07^3 = $14.58

The worth of the stock price per share = $0.94 + $2.18 + $4.08 + $14.58 = $21.78.

Therefore, the stock worth per share at 7% rate of return is $21.78