MDK, Inc. is a high growth ﬁrm that has never paid a dividend. The company just issued a press release stating that next year it plans on paying an annual dividend of $0.34. It also stated that
Dividends are expected to increase by 40% a year for each of the following four years and then
Increase by 4% annually thereafter. The required rate of return on this stock is 15%. What is the
Expected price per share of MDK stock six years from now?

Question

Quizplus · Accepted Answer

First, we need to determine the expected dividend for each of the next six years. Using the information given, we can construct the following dividend schedule:

Year 1: $0.34
Year 2: $0.34 x 1.4 = $0.476
Year 3: $0.476 x 1.4 = $0.6664
Year 4: $0.6664 x 1.4 = $0.93296
Year 5: $0.93296 x 1.04 = $0.969451
Year 6: $0.969451 x 1.04 = $1.007862

Next, we can use the dividend discount model to calculate the expected price per share six years from now:

P = D / (r - g)

where:
P = price per share
D = expected dividend in Year 6
r = required rate of return
g = expected growth rate of dividends from Year 5 to Year 6

Plugging in the numbers, we have:

P = $1.007862 / (0.15 - 0.04) = $12.844

Therefore, the expected price per share of MDK stock six years from now is $12.84, which is answer choice D.

MDK, Inc Is a High Growth ﬁRm That Has Never Paid