Question

Dolemite mines just paid a dividend of $2.00, its dividends are expected to grow at 5.00% forever. Investors required return on the stock is 13.00%. What is Dolemite's dividends for the next three years? Dividends Dividend in Year 1 Dividend in Year 2 If you were going to buy the stock today and sell it next year, at what price would you expect to sell the stock for, assuming the growth rate and required return remains unchanged? Stock Price in Year 1: What is the present value of next year's dividend and the selling price? Present Value of the Dividend Present Value of the Stock price next year Total Present Value of Dividends and Stock Price What is Dolemite's stock price using the constant dividend growth model? Ending Value – Beginning Value What is the growth rate of the stock price from today to next year? (Hint: Growth = = Beginning Value What is the dividend yield on the stock (Hint: dividend yield = - Dividend Current Price What is the investor expected return for holding the stock over the next year? %

Answer 1

Dividend paid (D0) = $2.00

i). Expected growth rate forever(g) = 5.00%

- Dividend in year 1 (D1) = D0(1+g)

= 2.00(1+0.05)

= $2.10

- Dividend in year 2 (D2) = D1(1+g)

= 2.10(1+0.05)

= $2.205

- Dividend in year 3 (D3) = D2(1+g)

= 2.205(1+0.05)

= $2.315

ii).

- Calculating the Stock Price in Year 1:-

$P_1= \frac{D_{2}}{Ke-g}$

D2 = $ 2.205

g = 5%

Ke = Required return on stock = 13%

$P_1= \frac{2.205}{(0.13-0.05)}$

P1 = $ 27.5625

So, Stock price in Year 1 is $27.5625

iii).

- Calculating the Present Value(PV) of the followings:-

PV of next year's dividend = D1/(1+ke)^1

= 2.10/(1+0.13)^1

= $ 1.8584

PV of next year's Stock price = P1/(1+ke)^1

= 27.5625/(1+0.13)^1

= $ 24.3916

Total PV = $1.8584 + $ 24.3916

= $ 26.25

iv).

Calculating Dolemite's Stock price using Constant Growth Model:-

$Price= \frac{D_{1}}{Ke-g}$

D1 = $ 2.1

g = 5%

Ke = Required return on stock = 13%

$Price= \frac{2.1}{(0.13-0.05)}$

P1 = $ 26.25

So, Stock price is $26.25

- Claculating Growth rate of the Stock Price :-

Growth rate = (Ending Value - Beginning Value)/Beginning Value

= (27.5625 - 26.25)/26.25

= 5%

- Calculating Dividend yield:-

Dividend yield = Annual Dividend/Current Price

= $2.10/$26.25

= 8%

- Total Investor's Expected return for holding the stock = Growth return + Dividend Yield

= 5% + 8%

= 13%

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