Question

7. The stock of Top of the Muffin currently pays a dividend of $11.40. The dividend is expected to grow by 20% per year for the next three years. In year 4 it will increase by $6.50 over the previous year, and after that point it will grow at 3% per year for the foreseeable future. If you require a 10.7% return for investing in this stock, what is a share of the stock worth to you today

Answer 1

Answer:

= $291.09

Explanation:

                                                                      PV of dividend ($)

Year 1      11.40 × 1.2× 1.107^(-1) =                        12.357

Year 2      11.40 × 1.2^2 × 1.107^(-2)=                 13.395

Year 3      11.40 × 1.2^3 × 1.107^(-3)=                   14.521

Year 4     ( ( 11.40 × 1.2^3) + 6.50 ) × 1.107^(-4) = 17.446

Year 5 and after

This will be done in two steps:

Step 1

PV( in year 4 terms)

=( ( 11.40 × 1.2^3) + 6.50 ) × 1.107 )/ 0.107 - 0.03

=$350.456

Step 2

PV (in year 0 term)

=350.4568312× 1,107^(-4)

= 233.369

The worth of the stock

= 12.357 + 13.395 + 14.521 + 17.446 + 233.369

= $291.09