Question

Chapter 8 3) ACME Corporation is expecting a period of intense growth and has decided to retain more of their earnings to help finance that growth. As a result, they are going to reduce the annual dividend by 5% a year for the next five years. After that they will maintain a constant dividend of $1.19 a share. Last year, the company paid $3.39 as the annual dividend per share. What is the market value of this stock if the required rate of return is 9%? Please show all the calculations by which you came up with the final answer. (5 Points) Answer:

Answer 1

market value of stock = present value of next 5 years dividends + present value of terminal value at end of 5 years

terminal value at end of 5 years = constant dividend / required return = $1.19 / 9% = $13.22

present value = future value / (1 + required return)^{number of years}

market value of stock = $20.03

B C D E PV of Terminal PV of terminal 1 Year Dividend value dividend value 2 1 $3.22 $2.95 3 2 $3.06 $2.58 3 $2.91 $2.24 4 $2.76 $1.96 5 $2.62 $13.22 $1.70 $8.59 Market value $20.03

PV of terminal value Terminal value 1 Year Dividend 2 1 =3.39*(1-5%) 32 =B2*(1-5%) 4 3 =B3*(1-5%) =B4*(1-5%) =B5*(1-5%) Market value PV of dividend =B2/(1+9%)^A2 =B3/(1+9%)^A3 =B4/(1+9%)^A4 =B5/(1+9%)^A5 =B6/(1+9%)^A6 =SUM(D2:06)+E6 =1.19/9% =C6/(1+9%)^A6