Otobai Motor Company just paid a dividend of $1.40.Analysts expect its dividend to grow at a rate of 18% for the next three years and then a constant rate of 5% thereafter.What is the expected dividend per share at the end of year 5?
A)$2.35
B)$2.54
C)$2.91
D)$1.50

Question

Quizplus · Accepted Answer

Using the dividend growth model:
D1 = D0 * (1 + g) = $1.40 * (1 + 0.18) = $1.65 (Dividend at the end of year 1)
D2 = D1 * (1 + g) = $1.65 * (1 + 0.18) = $1.95 (Dividend at the end of year 2)
D3 = D2 * (1 + g) = $1.95 * (1 + 0.18) = $2.30 (Dividend at the end of year 3)
We assume the constant growth rate of 5% starts from the end of year 3:
D4 = D3 * (1 + g) = $2.30 * (1 + 0.05) = $2.42 (Dividend at the end of year 4)
D5 = D4 * (1 + g) = $2.42 * (1 + 0.05) = $2.54 (Dividend at the end of year 5)

Therefore, the expected dividend per share at the end of year 5 is $2.54. Option B is the correct answer.

Otobai Motor Company Just Paid a Dividend of $1