Question

BT Alex Brown Analysts are evaluating Energen (NYSE: EGN) for possible inclusion in a small-cap oriented portfolio. EGN is a diversified energy company involved in oil & gas products. As a result of EGN’s aggressive program of purchasing oil and gas producing properties, BT Alex Brown expects above-average growth for the next five years. The analysts establish the following facts and forecasts for EGN: Current market price is $20 Current dividends are $0.54 Required return on equity is 11% Initial 2-year period of 15% per year earnings and dividend growth Which of the following is closest to the present value of dividends for the first-two years? $0.62 $1.14 $0.71$1.34

Answer 1

Answer:

The correct option is $1.14

Explanation:

D1=D0*(1+g)

D1 is year 1 dividend

g growth rate of dividend of 15%

D1=$0.54*(1+15%)

D1=$0.54*(1+0.15)

D1=$0.54*1.15

D1=$0.621 00

D2=$0.621*1.15

D2=$0.71415

We need to apply the discount factor to each of the dividends,the discount factor is 1/(1+r)^n

r is the rate of return of 11%

n is the relevant year

present value of year 1 dividend=$0.62100*1/(1+11%)^1

present value of year 1 dividend=$0.559459459

Present value of year 2=$0.71415*1/(1+11%)^2

Present value of year 2=$0.579620161

Total value present values=$0.559459459 +$0.579620161

                                            =$1.14