Question

Moody Farms just paid a dividend of $3.95 on its stock. The growth rate in dividends is expected to be a constant 5 percent per year indefinitely. Investors require a return of 14 percent for the first three years, a return of 12 percent for the next three years, and a return of 10 percent thereafter. What is the current share price

Answer 1

Answer:

$81.52

Explanation:

The current share price is the present value of future dividends as well as the present value of the terminal value of dividends beyond year 6 as shown thus:

Current dividend=$3.95

Year 1 dividend=$3.95*(1+5%)=$4.15

Year 2 dividend=$4.15*(1+5%)=$4.36

Year 3 dividend=$4.36*(1+5%)=$4.58

The required rate of return(discount rate) for the dividends in the FIRST 3 years above is 14%

Year 4 dividend=$4.58*(1+5%)=$4.81

Year 5 dividend=$4.81*(1+5%)=$5.05

Year 6 dividend=$5.05*(1+5%)=$5.30

The required rate of return(discount rate) for the dividends in the NEXT 3 years above is 12%

Terminal value of dividend=Year 6 dividend*(1+growth rate)/(rate of return-growth rate)

growth rate=5%

rate of return=10%(rate of return thereafter)

terminal value=$5.30*(1+5%)/(10%-5%)

terminal value=$111.30

current share price=$4.15/(1+14%)+$4.36/(1+14%)^2+$4.58/(1+14%)^3+$4.81/(1+12%)^4+$5.05/(1+12%)^5+$5.30/(1+12%)^6+$111.30/(1+10%)^6

current share price=$81.52