Now or Later, Inc. recently paid $1.10 as an annual dividend. Future dividends are projected at $1.14, $1.18, $1.22, and $1.25 over the next four years, respectively. Beginning ﬁve years from now, the
Dividend is expected to increase by 2% annually. What is one share of this stock worth to you if you
Require an 8% rate of return on similar investments?

Question

Quizplus · Accepted Answer

To calculate the present value of the dividends, we need to use the dividend discount model:
PV = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^ 3 + D4/(1+r)^4 + D5/(1+r)^5 + D6(1+g)/(r-g)/(1+r)^5
Where:
D1 = $1.14
D2 = $1.18
D3 = $1.22
D4 = $1.25
D5 = $1.25*(1+0.02) = $1.28
D6 = $1.28*(1+0.02) = $1.31
r = 8%
g = 2%
Using the above formula, we get:
PV = $1.14/(1+0.08) + $1.18/(1+0.08)^2 + $1.22/(1+0.08)^3 + $1.25/(1+0.08)^4 + $1.28/(1+0.08)^5 + $1.31/(0.08-0.02)/(1+0.08)^5
PV = $15.79
Therefore, one share of this stock is worth $15.79 to you if you require an 8% rate of return on similar investments. The closest option is B, $19.57, but that is not the exact answer.