Question

Ex 4) The CI Corp. has just paid a cash dividend of $2 per share. If investors require 16% return from investments such as this and the dividend is expected to grow at a steady 8% per year, what is the current value of the stock? What will the stock be worth in 5 years, given the same assumptions about the required return and the dividends? Answer: $27; $39.67

Ex 5) A stock is selling for $40 per share currently. The next dividend will be $1 per share, and will grow at 12% per year forever. What is the rate of return required by investors? Answer: 14.5%

Ex 6) A tech start-up company has just become public. It just paid $3 dividend per share, which will grow 10% for the next two dividends. Afterwards, the dividends will level off and grow at 4% per year forever. If the investors require 6% return on similar investments, what is the price of stock? Answer:

Answer 1

4. D₁ = Expected dividend = $2 X (1+8%) = $2.16

Required return on investment (r) = 16%

Growth rate (g) = 8%

Therefore, current value of stock (P₀) = D₁ / (r-g) = $2.16 / (16% - 8%) = $27.

The worth of the stock in 5 years = P₀ X (1 + 8%)^5 = $27 X (1 + 8%)^5 = $39.67.

5. D₁ = $1

Growth rate (g) = 12%

P₀ = $40

Therefore, required rate of return (r) = D₁ / P₀ + g = $1 / $40 + 12% = 14.50%.

6. D₁ = Expected dividend = $3 X (1+10%) = $3.3

n = 2 years

r= 6%

g₁ = 10%

g₂ = 4%

Plugging in the values in the above equation, we find the price of the stock (P₀) to be $174.34.