The Slim Waist announced today that they will begin paying annual dividends. The ﬁrst dividend will be paid next year in the amount of $.35 a share. The following dividends will be $.40, $.55, and
$)70 a share annually for the following three years, respectively. After that, dividends are projected
To increase by 2.5% per year. How much are you willing to pay to buy one share of this stock if your
Desired rate of return is 12%?

Question

Quizplus · Accepted Answer

Firstly, we need to calculate the present value of all the dividends until perpetuity. Using the dividend discount model, we get:
PV = (0.35 / 1.12) + (0.40 / 1.12^2) + (0.55 / 1.12^3) + (0.70 / 1.12^4) + [(0.70 * 1.025) / (0.12 - 0.025)] / (1.12^4)
PV = 0.3125 + 0.3057 + 0.3721 + 0.4145 + 8.1775
PV = 9.5823
Now, we can use this PV to find the present value of the stock using the dividend discount model:
9.5823 = D / (0.12 - g)
Assuming that the growth rate will be 2.5%, we get:
D / 0.0975 = 9.5823
D = 0.9317
Therefore, the fair value of the stock is $0.9317, which when rounded off to two decimal places is $6.27. Hence, the best choice is (E).

The Slim Waist Announced Today That They Will Begin Paying