Question

OMG Corporation just paid a $2.90 annual dividend on each share. It is planning on increasing its dividend by 15 percent a year for the next 4 years. The corporation will then decrease the growth rate to a rate of 6 percent per year, and keep it that way indefinitely. The required rate of return is 8.40 percent. Calculate the current value of one share of this corporation's stock.

Multiple Choice

$226.92

$162.24

$178.62

$224.02

$175.72

Answer 1

Step-1, Calculation of Dividend per share for the next 4 years

Dividend in Year 0 (D0) = $2.90 per share

Dividend in Year 1 (D1) = $3.3350 per share [$2.90 x 115%]

Dividend in Year 2 (D2) = $3.8353 per share [$3.3350 x 115%]

Dividend in Year 3 (D3) = $4.4105 per share [$3.8353 x 115%]

Dividend in Year 4 (D4) = $5.0721 per share [$4.4105 x 115%]

Step-2, Calculation of Stock Price for the Year 4 (P4)

Here, we have Dividend per share in year 4 (D4) = $5.0721 per share

Dividend Growth Rate (g) = 6.00% per year

Required Rate of Return (Ke) = 8.40%

Stock Price for the Year 4 = D4(1 + g) / (Ke – g)

= $5.0721(1 + 0.06) / (0.0840 – 0.06)

= $5.3764 / 0.0240

= $224.02 per share

Step-3, Current price of the stock (P0)

As per Dividend Discount Model, the Value of the Stock is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 4

Year	Cash flow ($)	Present Value Factor (PVF) at 8.40%	Present Value of cash flows ($) [Cash flows x PVF]
1	3.3350	0.92251	3.08
2	3.8353	0.85102	3.26
3	4.4105	0.78508	3.46
4	5.0721	0.72424	3.67
4	224.02	0.72424	162.24
TOTAL	175.72