Phoenix industries has pulled off a miraculous recovery. Four years ago it was n
ID: 2637310 • Letter: P
Question
Phoenix industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the first dividend since the crisis. Analysts expect dividends to increase by $1 a year for another two years (the dividend in year 2 will be $2 and the dividend in year 3 will be $3). After the third year (in which dividends are $3 per share) dividend growth is expected to settle down to a more moderate long-term growth rate of 6%. Assume that the firm
Explanation / Answer
P0=D1/(RETURN ON EQUITY - GROWTH RATE)
P3 = 3.18/(0.14-0.06)
= $ 39.75
P0 = 39.75/(1.14^3)
= $ 26.83
For computing P0, we would again discount price at the end of third year to end of 1 st year by using discount rate @14%.
YEAR DIVIDEND 1 1 2 2 3 3 4 3.18 5 3.37 6 3.57 INCREASING @ 6% LIKE THIS