Sugar Cookies will pay an annual dividend of $1.23 a share next year. The firm expects to increase this dividend by 8 percent per year the following four years and then decrease the dividend growth to 2 percent annually thereafter. Which one of the following is the correct computation of the dividend for Year 7?

a. ($1.23) * (1.08) 4 * (1.02) 4

b. ($1.23) * (1.08 * 4) * (1.02 * 3)

c. ($1.23) * (1.08) 4 * (1.02) 3

d. ($1.23) * (1.08) 4 * (1.02) 2

e. ($1.23) * (1.08 * 4) * (1.02 * 2)

The correct answer is c) ($1.23) * (1.08) 4 * (1.02) 3

Explanation:

The c) option correctly use the future value formula to compute the future value of the dividen by the year 7.

The fure value formula is FV = PV (1 + i) n

where:

FV = Future value PV = Present value (in this case $1.23) i = interest rate (in this case, 8% or 0.08 for the first 4 years, and thereafter, 2% or 0.02 for the last three years) n = number of periods (in this case, number of years).

So replacing you get: FV = $1.23 (1+0,08) 4 x (1+0,02) 3

=$1.23 (1,08) 4 x (1,02) 3

=16,2