Question

Over the next three years, Distant Groves wl pay annual dividends of $.65, S.70, and $.75 a share, respectively. After that, dividends are projected to Increase by 2 percent per year. What is one share of this stock worth today at a required return of 14.5 percent?
a) $5.49
b) $5.94
c) $5.68
d) $5.55
e) $5.86

Answer 1

Answer:

c) $5.68

Explanation:

The worth of this stock today is the present value of the future dividends which is computed by discounting future dividends as well as the terminal value using the required rate of return of 14.5% as the appropriate discount rate as shown thus:

Year 1 dividend=$.65

Year 2 dividend=$0.70

Year 3 dividend=$0.75

terminal value of dividends=Year 3 dividend*(1+g)/Ke-g

g=dividend terminal growth rate=2%

Ke=required rate of return=14.5%

terminal value of dividends=$0.75*(1+2%)/(14.5%-2%)=$ 6.12  

Share price=$.65/(1+14.5%)^1+$.70/(1+14.5%)^2+$.75/(1+14.5%)^3+$6.12/(1+14.5%)^3

share price=$5.68