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21 November, 00:47

Lohn Corporation is expected to pay the following dividends over the next four years: $14, $10, $9, and $4.50. Afterward, the company pledges to maintain a constant 4 percent growth rate in dividends forever. If the required return on the stock is 10 percent, what is the current share price

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  1. 21 November, 02:16
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    Current share price is $59.88

    Explanation:

    First calculate present value of all four years dividend

    Year Calculations PV

    1. 14 x (1.10) ^-1 $12.73

    2. 10 x (1.10) ^-2 $8.26

    3. 9 x (1.10) ^-3 $6.76

    4. 4.5 x (1.10) ^-4 $3.07

    As the Dividend in fifth year will grow for indefinite period of time, This is the perpetuity payment. The value of share can be determined by calculating the present value of perpetuity payment.

    Dividend in the fifth year = $4.5 x (1 + 4%) = $4.68

    The formula for the present value of perpetuity is as follow

    Present value of perpetuity = Dividend / Required Rate of return

    Value of Stock = Dividend / Required Rate of return

    Value of Stock = $4.68 / 10%

    Value of Stock = $46.8

    This the value in fifth year calculate it present value

    Today's value = $46.8 x (1 + 10%) ^-5 = $29.06

    Now add the all present values

    Total Present value = $12.73 + $8.26 + $6.76 + $3.07 + $29.06 = $59.88
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