Banner Corporation will not pay dividends until year 3, whereby it is expected to pay $5 in dividends. Dividends are then expected to grow at 20%, 10% and 5% in years 4, 5 and 6. Afterwards, dividend growth will stabilize to 2% consistently. If the rate of return is 10%, determine the stock price next year.

Question

Quizplus · Accepted Answer

To find the stock price next year (year 1), we need to calculate the present value of expected dividends starting from year 3. The dividends are $5 in year 3, growing at 20% in year 4, 10% in year 5, and 5% in year 6. From year 7 onwards, dividends grow at a constant rate of 2%. We calculate the present value of dividends for years 3 to 6 and the present value of the perpetuity starting from year 7. The sum of these present values gives the stock price in year 1, which is approximately $72.31.

Banner Corporation Will Not Pay Dividends Until Year 3, Whereby