Energistics, Inc. plans to retain and reinvest all of its earnings for the next three years; at the end of year 3 the firm will pay a special dividend of $5 per share. Beginning in year 4, the firm will begin to pay a dividend of $1 per share, which is expected to grow at a 3% rate annually forever. Given a required return of 12%, the stock should sell for _____ today.

Question

Quizplus · Accepted Answer

The correct answer is A because the stock should sell for $11.47 today. This is calculated by using the dividend discount model, which takes into account the present value of all future dividends. The special dividend of $5 per share at the end of year 3 is worth $5/(1.12^3) = $3.57 today. The annual dividend of $1 per share, which is expected to grow at a 3% rate annually forever, is worth $1/(0.12 - 0.03) = $10.00 today. The total value of the stock is therefore $3.57 + $10.00 = $11.47.