Answer:
Find my detailed explanations and answers below
Explanation:
a.
The dividend in the future is the current dividend multiplied by dividend growth factor as shown thus:
Year 1 dividend=$2.40*(1+20.00%)=$2.88
Note that the growth rate after year 1 is 4.00%
Year 2 dividend=$2.88*(1+4.00%)=$3.00
Year 3 dividend=$3.00*(1+4.00%)=$3.12
b.
The stock price today is the present value of dividend in year 1 and the present value of the terminal value of dividend beyond year 1
Year 1 dividend=$2.88
terminal value=year 1 dividend*(1+terminal growth rate)/(cost of equity-terminal growth rate)
terminal growth rate=4.00%
cost of equity=risk-free rate+(beta*market risk premium)
cost of equity=3%+(1.9*3.6%)=9.84%
terminal value=$2.88*(1+4.00%)/(9.84%-4.00%)
terminal value=$51.29
stock price today=$2.88/(1+9.84%)^1+$51.29/(1+9.84%)^1
stock price today=$49.32
c.
Year 1 dividend=$2.88
Year 2 dividend=$3.00
Year 3 dividend=$3.12
Year 4 dividend=$3.12*(1+4.00%)=$3.24
Terminal value beyond year 4 is the price after year 4(let us assume it is X)
$49.32=$2.88/(1+9.84%)^1+$3.00/(1+9.84%)^2+$3.12/(1+9.84%)^3+$3.24/(1+9.84%)^4+X/(1+9.84%)^4
$49.32=$9.69+X/(1+9.84%)^4
$49.32-$9.69=X/(1+9.84%)^4
$39.63=X/(1+9.84%)^4
X=$39.63*(1+9.84%)^4
X=$57.69
Alternative approach:
terminal value beyond year 4=$3.24*(1+4.00%)/(9.84%-4.00%)
terminal value beyond year 4=$57.70(difference of $0.01 due to rounding error)
