Chahal Corporation is expected to pay dividends of $12, $9, $6, and $3 over the next four years. The company plans to maintain a constant 4% growth rate in dividends afterwards. If the required
Return on the stock is 11%, what is the current share price?

Question

Quizplus · Accepted Answer

We can use the constant growth dividend discount model to calculate the current share price:

Step 1: Calculate the present value of the four dividends using the formula for the present value of a growing perpetuity (since the dividends are expected to grow at a constant rate):

PV(Dividends) = D1/(r-g)
PV(Dividend 1) = 12/(1+0.11)^1 = 10.81
PV(Dividend 2) = 9/(1+0.11)^2 = 7.27
PV(Dividend 3) = 6/(1+0.11)^3 = 4.55
PV(Dividend 4) = 3/(1+0.11)^4 = 2.48

PV(Dividends) = 10.81 + 7.27 + 4.55 + 2.48 = 25.11

Step 2: Calculate the present value of the expected future dividends beyond year 4 using the formula for the present value of a growing perpetuity:

PV(Expected Future Dividends) = D5/(r-g)

We know that D5 = D4 * (1+g) = 3 * (1+0.04) = 3.12
So, PV(Expected Future Dividends) = 3.12/(0.11-0.04) = 44.57

Step 3: Calculate the current share price by adding the present values of the dividends:

Current Share Price = PV(Dividends) + PV(Expected Future Dividends) = 25.11 + 44.57 = $69.68

Therefore, the best choice is D.

Chahal Corporation Is Expected to Pay Dividends of $12, $9