Question

The dividend for Should I, Inc., is currently $1.40 per share. It is expected to grow at 16 percent next year and then decline linearly to a perpetual rate of 4 percent beginning in four years. If you require a return of 12 percent on the stock, what is the most you would pay per share

Answer 1

Answer:

The most you would pay per share is $18.90 price per share today.

Explanation:

Note: See the attached file for the calculation of present values for year 1 to 3 dividends.

From the attached excel file, we have:

Previous year dividend in year 1 = Dividend just paid = $1.40

Total of PV of dividends from year 1 to year 3 = $4.50720663265306

Year 3 dividend = $1.55542091836735

Therefore, we have:

Year 4 dividend = Year 3 dividend * (100% + Dividend growth rate in year 4) = $1.55542091836735 * (100% + 4%) = $1.61763775510204

Price at year 3 = Year 4 dividend / (Rate of return - Perpetual dividend growth rate) = $1.61763775510204 / (12% - 4%) = $20.2204719387755

PV of price at year 3 = Price at year 3 / (100% + Required return)^Number of years = $20.2204719387755 / (100% + 12%)^3 = $14.3925325274857

Price per share today = Total of PV of dividends from year 1 to year 3 + PV of price at year 3 = $4.50720663265306 + $14.3925325274857 = $18.90

Therefore, the most you would pay per share is $18.90 price per share today.

Download xlsx