Question

Merriweather's has a policy of increasing its annual dividend by 1.75 percent each year. How much will one share be worth five years from now if the required rate of return is 15 percent and the next dividend will be $3.40

Answer 1

Answer:

P5 = $27.98563259 rounded off to $27.99

Explanation:

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D0 * (1+g) / (r - g)

Where,

• Do is the last dividend paid

• D0 * (1+g) is dividend expected for the next period  or D1

• g is the growth rate

• r is the required rate of return  

To calculate the price today (P0) we use D1 or dividend expected for the next period.Similarly, to calculate the price 5 years from now or P5, we will use D6. We will calculate D6 first and use it in the above formula in place of the numerator. We are given D1 as 3.4

D6 = 3.4 * (1+0.0175)^5

D6 = $3.708096319

The price of the stock 5 years from now will be,

P5 = 3.708096319 / (0.15 - 0.0175)

P5 = $27.98563259 rounded off to $27.99