A firm recently paid a $0.50 annual dividend. The dividend is expected to increase by 10% in each of the next three years. In the third year, the stock price is expected to be $110. If the required return is 15%, what is its value?

Question

Quizplus · Accepted Answer

To find the value of the stock, we need to calculate the present value of all the future cash flows.

Step 1: Calculate the future dividends
Year 1 dividend = $0.50 x 1.10 = $0.55
Year 2 dividend = $0.55 x 1.10 = $0.605
Year 3 dividend = $0.605 x 1.10 = $0.6655

Step 2: Calculate the present value of the dividends using the dividend discount model
PV = D1/(1+R)^1 + D2/(1+R)^2 + D3/(1+R)^3 + P3/(1+R)^3
PV = $0.55/(1+0.15)^1 + $0.605/(1+0.15)^2 + $0.6655/(1+0.15)^3 + $110/(1+0.15)^3
PV = $0.4783 + $0.4735 + $0.4505 + $57.60
PV = $73.71

Therefore, the value of the stock is $73.71, which is closest to option C.

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