Question

The Extreme Reaches Corp. last paid a $1.50 per share annual dividend. The company is planning on paying $3.00, $5.00, $7.50, and $10.00 a share over the next four years, respectively. After that the dividend will be a constant $2.50 per share per year forever. What is the market price of this stock if the market rate of return is 15 percent

Answer 1

Answer:

Market price of share = $26.57

Explanation:

According to the dividend valuation model, the value of a stock is the present value of the expected future dividends from the stock discounted at the the required rate of return.

The required  rate of return here is 15%

The dividend growth model a be applied to each of the years as appropriate.

The share price of Extreme Reaches Corp can be computed as follows:

Year                     working                  Present value of Dividend  

1                          3.00 × (1.15) ×(-1) =        2.61

2                             5× (1.15)^(-2) =           3.78

3                            7.50× (1.15^(-3) =         4.93

4                             10.0×  1.15^(-4) =         5,72

5  to infinity        (see working)     =           9.52

Present value                                               26.57

Working

Present value of dividend from Year 5 to infinity

PV (in year 4) of dividend from  year 5 to infinity = 2.50× 1/(1.15)= 16.66

Present value in year 0 = PV in year 4× 1.15^(-4)

Present value in year 4 = 16.66× 1.15^(-4) = 9.52

Market price of share = $26.57