Value of Future Cash Flows A firm recently paid a $1.00 annual dividend. The dividend is expected to increase by 10 percent in each of the next four years. In the fourth year, the stock price is expected to be $100. If the required rate for this stock is 14 percent, what is its current value?

Question

Quizplus · Accepted Answer

The current value of the stock can be calculated as the sum of the present value of all its future cash flows.

Dividend in year 1 = $1.00 
Dividend in year 2 = $1.10 
Dividend in year 3 = $1.21 
Dividend in year 4 = $1.33 
Expected stock price in year 4 = $100

Using the dividend discount model:

PV of dividend in year 1 = $1.00 / (1 + 0.14) = $0.877 
PV of dividend in year 2 = $1.10 / (1 + 0.14)^2 = $0.734 
PV of dividend in year 3 = $1.21 / (1 + 0.14)^3 = $0.609 
PV of dividend in year 4 = $1.33 / (1 + 0.14)^4 = $0.476

PV of expected stock price in year 4 = $100 / (1 + 0.14)^4 = $47.61

Current value of stock = $0.877 + $0.734 + $0.609 + $0.476 + $47.61 = $62.87

Therefore, the best choice is C, $62.87.

Value of Future Cash Flows a Firm Recently Paid a $1.00