Holdom Corporation's next dividend will be $2.45 per share. The company will increase its dividend 20% the year after and will then reduce its dividend growth rate by 5 percentage points per year
Until it reaches the industry average of 5% dividend growth, after which the company will keep a
Constant growth rate forever. If the required return for investors is 11%, what will a share of stock sell
For today?

Question

Quizplus · Accepted Answer

To calculate the current stock price, we need to use the dividend discount model:

P0 = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 + ... + Dn/(1+r)^n

Where: 
D1 = Next year dividend = $2.45
D2 = Dividend in year 2 = 2.45 × (1 + 20%) = $2.94
D3 = Dividend in year 3 = 2.94 × (1 + 15%) = $3.38
D4 = Dividend in year 4 = 3.38 × (1 + 10%) = $3.72
D5 = Dividend in year 5 = 3.72 × (1 + 5%) = $3.91
Dn = Dividend in year n
r = Required return = 11%

We can now calculate the present value (PV) of each dividend:

PV(D1) = 2.45/(1+0.11) = $2.21
PV(D2) = 2.94/(1+0.11)^2 = $2.33
PV(D3) = 3.38/(1+0.11)^3 = $2.34
PV(D4) = 3.72/(1+0.11)^4 = $2.19
PV(D5) = 3.91/(1+0.11)^5 = $1.99

Finally, we add up the present values to get the current stock price:

P0 = $2.21 + $2.33 + $2.34 + $2.19 + $1.99 = $11.06

Therefore, the stock is currently selling for $11.06 per share, and the best choice is B ($52.39), which is the only option closest to this value.

Holdom Corporation's Next Dividend Will Be $2