Question

The stock of Top of the Muffin currently pays a dividend of $2.85. The dividend is expected to grow by 30% per year for the next three years. In year 4 it will increase by $2.40 over the previous year, and after that point it will grow at 2% per year for the foreseeable future. If you require an 10.8% return for investing in this stock, what is a share of the stock worth to you today?

Answer 1

Answer:

Consider the following calculation

Explanation:

Year 1 dividend = 2.85 (1 + 30%) = 3.705

Year 2 dividend = 3.705 (1 + 30%) = 4.8165

Year 3 dividend = 4.8165 (1 + 30%) = 6.26145

Year 4 dividend = 6.26145 + 2.4 = 8.66145

Year 5 dividend = 8.66145 (1 + 2%) = 8.834679

Value at year 4 = D5 / required rate - growth rate

Value at year 4 = 8.834679 / 0.108 - 0.02

Value at year 4 = 8.834679 / 0.088

Value at year 4 = 100.39408

Share price = Present value of cash inflows

Share price = 3.705 / (1 + 0.108)1 + 4.8165 / (1 + 0.108)2 + 6.26145 / (1 + 0.108)3 + 8.66145 / (1 + 0.108)4 + 100.39408 / (1 + 0.108)4

Share price = $84.23