Question

Sawchuck Consulting has been profitable for the last 5 years, but it has never paid a dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's forecast of the future dividend stream, along with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value?Year 0 1 2 3 4 5 6Growth rate NA NA NA NA 50.00% 25.00% 8.00%Dividends $0.000 $0.000 $0.000 $0.250 $0.375 $0.469 $0.506a. $9.94b. $10.19c. $10.45d. $10.72e. $10.99

Answer 1

Answer:

The answer is d

Explanation:

This question is assessing the dividend growth model which is used to assess how profitable a company is based on its stock valuation. Sawchuck's stock's current value is computed via a multi-stage dividend growth model. The growth rate of 50% in year 4 and 25% in year 5 is used to compute the expected cash flows in those years. Thereafter, the 8% perpetuity rate is applied to compute the expected dividend in perpetuity. After this, the present values (PV) of these cash flows are computed using the required rate of  return of 11.00%. After this, the present value of the stable dividend growth is computed as an estimate of anticipated future cash flows. The resulting valuation of 10.72798286  is obtained via summation of all present values:

1. PV of Year 3: 0.182797845  ( 0.25/(1.11ᶺ3 ))
2. PV of Year 4: 0.247024115  ( 0.375/(1.11ᶺ4) )
3. PV of Year 5: 0.278328672  (0.469/(1.11ᶺ5) )
4. PV of dividend in perpetuity: 10.01983222

Please see attached file for further calculations.

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Answer 2

Answer:

The correct answer is d