Consider the following three stocks: a. Stock A is expected to provide a dividen
ID: 2731820 • Letter: C
Question
Consider the following three stocks: a. Stock A is expected to provide a dividend of $11.60 a share forever. b. Stock B is expected to pay a dividend of $6.60 next year. Thereafter, dividend growth is expected to be 5% a year forever. c. Stock C is expected to pay a dividend of $4.40 next year. Thereafter, dividend growth is expected to be 21% a year for five years (i.e., until year 6) and zero thereafter.
If the market capitalization rate for each stock is 8%, what is the stock price for each of the stocks?(Do not round intermediate calculations. Round your answers to 2 decimal places.)
b-1.If the market capitalization rate for each stock is 8%, what is the stock price for each of the stocks?(Do not round intermediate calculations. Round your answers to 2 decimal places.)
Explanation / Answer
Formula to calculate stock price with constant dividends forever:
Stock Price = D / Ke
Formula to calculate stock price with different dividends:
Stock Price = [D*(1+g)n] / (1+Ke)n] + [(Dc*(1+G)] / [(Ke-G)]
Where:
D = Current dividend
g = Growth rate
Ke = Cost of equity (Market capitalization rate)
n = Number of years
Dc = Last dividend before the constant growth phase
Price of stock A = $11.60 / 0.08 = $145
Price of stock B = ($6.60 / 1.08) + [($6.60*1.05) / (0.08-0.05)] = $237.42
Price of stock C:
Dividends:
D1 = $4.40
D2 = $4.40 x 1.21 = $5.324
D3 = $4.40 x 1.212 = $6.44
D4 = $4.40 x 1.213 = $7.79
D5 = $4.40 x 1.214 = $9.43
Terminal Value = $9.43 / 0.08 = $117.89
PV of dividends = [($4.40)/(1.08)] + [($5.324)/(1.08)2] + [($6.44)/(1.08)3] + [($7.79)/(1.08)4] + [($9.43)/(1.08)5] = $23.57
PV of terminal value = $117.89/(1.08)6 = $74.30
Stock Price = $23.57 + $74.30 = $97.87