Question

In doing a five-year analysis of future dividends, the Dawson Corporation is considering the following two plans. The values represent dividends per share. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.
Year Plan A Plan B
1 $1.90 $60
2 1.90 2.30
3 1.90 .20
4 2.40 5.00
5 2.40 1.60
a. How much in total dividends per share will be paid under each plan over five years? (Do not round intermediate calculations and round your answers to 2 decimal places.)
Total Dividends
Plan A $
Plan B $
b-1.
Mr. Bright, the Vice-President of Finance, suggests that stockholders often prefer a stable dividend policy to a highly variable one. He will assume that stockholders apply a lower discount rate to dividends that are stable. The discount rate to be used for Plan A is 8 percent; the discount rate for Plan B is 12 percent. Compute the present value of future dividends. (Do not round intermediate calculations and round your answers to 2 decimal places.)
b-2. Which plan will provide the higher present value for the future dividends?

Answer 1

Answer:

a. Total Dividends:

Plan A = $10.50

Plan B = $69.10

b-1. We have:

Present value of future dividends of Plan A = $8.29

Present value of future dividends of Plan B = $59.63

b-2. Plan B will provide the higher present value for the future dividends.

Explanation:

a. How much in total dividends per share will be paid under each plan over five years? (Do not round intermediate calculations and round your answers to 2 decimal places.)

Total Dividends per share of Plan A = $1.90 + $1.90 + $1.90 + $2.40 + $2.40 = $10.50

Total Dividends per share of Plan B = $60 + $2.30 + 0.20 + $5.00 + $1.60 = $69.10

b-1. Compute the present value of future dividends. (Do not round intermediate calculations and round your answers to 2 decimal places.)

The present value of each year dividend per share can be calculated using the following present value formula:

Present value per share for a year = Dividend per share for the year / (1 + r)^n .................. (1)

Where;

r = discount rate of each plan

n = the year being considered

Equation (1) is therefore used to calculate the present value of future dividends of each plan by adding the present values of all the years as follows:

Present value of future dividends of Plan A = ($1.90 / (1 + 8%)^1) + ($1.90 / (1 + 8%)^2) + ($1.90 / (1 + 8%)^3) + ($2.40 / (1 + 8%)^4) + ($2.40 / (1 + 8%)^5) = $8.29

Present value of future dividends of Plan B = ($60 / (1 + 12%)^1) + ($2.30 / (1 + 12%)^2) + ($0.20 / (1 + 12%)^3) + ($5.00 / (1 + 12%)^4) + ($1.60 / (1 + 12%)^5) = $59.63

b-2. Which plan will provide the higher present value for the future dividends?

From part b-1, we have:

Present value of future dividends of Plan A = $8.29

Present value of future dividends of Plan B = $59.63

Based on the above, Plan B will provide the higher present value for the future dividends.