Problem 8-33 Stock Valuation [LO1] Most corporations pay quarterly dividends on

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 $4.00 on its common stock in a single annual installment, and management plans on raising this dividend by 3 percent per year indefinitely. If the required return on this stock is 13 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 $1.000 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

Part A:

Last Dividend (D) = $4

Growth Rate in Dividend (g) = 3%

Required Rate of Return (R) = 13%

Expected Dividend (D1) = D*(1+g) = 4*(1+3%) = $4.12

Current Price = D1(R-g) = 4.12/(0.13-0.03) = $41.20

Part B

Since the dividend is paid in four instalment in the year the stock price can be determined by computing present value of each instalment.

Expected Dividend of each instalment = 1*(1+3%) = 1.03

Present Value = 1.03/(0.13-0.03) = 10.3

Stock Price = 10.3 + 10.3/(1+0.13/4) + 10.3/(1+0.13*2/4) + 10.3/(1+0.13*3/4) = $39.33

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects