Question

1. Stock Values. Integrated Potato Chips paid a $2 per share dividend yesterday. You expect the dividend to grow steadily at a rate of 4 percent per year. a. What is the expected dividend in each of the next 3 years? b. If the discount rate for the stock is 12 percent, at what price will the stock sell? c. What is the expected stock price 3 years from now? d. If you buy the stock and plan to hold it for 3 years, what payments will you receive? What is the present value of those payments? Compare your answer to (b).

Answer 1

Answer and Explanation:

The computation of each point is shown below:-

a. Expected dividend in each of the next 3 years is

Dividend in year 1 = Current Dividend × (1 + growth rate)

= 2 × (1 + 0.04)

= 2.08

Dividend in year 2 = Dividend in year 1 × (1 + growth rate)

= 2.08 × (1 + 0.04)

= 2.1632

Dividend in year 3 = Dividend in year 2 × (1 + growth rate)

= 2.1632 × (1 + 0.04)

= 2.249728

b Price the stock will sell

Current Price = Dividend in year 1 ÷ (Discount rate - growth rate)

= 2.08 ÷ (0.12 - 0.04)

= 26

c. Expected Price 3 years from now  is

Price in Year 3 =  Dividend in year 4 ÷ (Discount rate - growth rate)

= [2 × (1 + 0.04)^4] ÷ (0.12 - 0.04)

= 2.33971712 ÷ 0.08

= 29.246464

d. The present value of payments received is

Year       Dividend ÷ Price   PVF at 12%  Present Value of Dividend ÷ Price

0                    2                              1  

1 Dividend    2.08             0.892857143               1.857142857

2 Dividend  2.1632           0.797193878               1.724489796

3 Dividend   2.249728      0.711780248              1.601311953

3 Price at

year 3        29.246464      0.711780248              20.81705539

                                                 Total                          26

Note

Here the present value is the same as we have calculated in part b.