Ultra Fine Furnishings is in the process of selling its peripheral businesses and focusing on its upscale clients. In conjunction with this reorganization, the dividend will be decreased by 10 percent for the next 3 years. After that, the dividend will resume increasing at an annual rate of 5 percent. The required return on this stock is 14 percent and the last dividend paid was $2.40 a share. What is one share of this stock worth today?

Question

Quizplus · Accepted Answer

Step 1: Determine the dividend in years 1-3:
$2.40 x (1 - 0.10) = $2.16

Step 2: Determine the dividends in year 4 and beyond:
D4 = $2.16 x 1.05 = $2.27 (approx.)
D5 = $2.27 x 1.05 = $2.38 (approx.)
D6 = $2.38 x 1.05 = $2.50 (approx.)
and so on...

Step 3: Determine the present value of the dividends for years 1-6:
PV = $2.16 / (1 + 0.14)^1 + $2.16 / (1 + 0.14)^2 + $2.16 / (1 + 0.14)^3 + $2.27 / (1 + 0.14)^4 + $2.38 / (1 + 0.14)^5 + $2.50 / (1 + 0.14)^6
PV = $12.19

Step 4: Determine the present value of the stock price:
P = D / (r - g)
P = $2.50 / (0.14 - 0.05)
P = $23.81

Step 5: Determine the present value of the stock today:
PV = P / (1 + r)^n
PV = $23.81 / (1 + 0.14)^1
PV = $20.72

Therefore, the value of one share of this stock today is $18.35 (Choice C on the answer list).

Ultra Fine Furnishings Is in the Process of Selling Its