Problem 8-33 Stock Valuation [LO1] Most corporations pay quarterly dividends on
ID: 2777870 • Letter: P
Question
Problem 8-33 Stock Valuation [LO1]
Most corporations pay quarterly dividends on their common stock rather than annual dividends. Barring any unusual circumstances during the year, the board raises, lowers, or maintains the current dividend once a year and then pays this dividend out in equal quarterly installments to its shareholders.
a. Suppose a company currently pays an annual dividend of $4.10 on its common stock in a single annual installment, and management plans on raising this dividend by 4 percent per year indefinitely. If the required return on this stock is 14 percent, what is the current share price? (Round your answer to 2 decimal places. (e.g., 32.16))
Current share price $
b. Now suppose the company in (a) actually pays its annual dividend in equal quarterly installments; thus, the company has just paid a dividend of $1.025 per share, as it has for the previous three quarters. What is your value for the current share price now? (Hint: Find the equivalent annual end-of-year dividend for each year.) (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Current share price $
Explanation / Answer
Answer:
Cost of equity = (Dividend / Rate of Return) + Increse in Dividend rate
a, Cost of equity = (4.10 / 0.14) + 0.04
Hence, Cost of Equity = $29.33
The current share price will be $29.33
b. Annual Dividend = 1.025* 4 = 4.1
Hence,
Cost of equity = (4.10 / 0.14) + 0.04
Hence, Cost of Equity = $29.33
The current share price will be $29.33