Sweatshirts Unlimited is downsizing.The company paid a $2.80 annual dividend last year.The company has announced plans to lower the dividend by 25 percent each year.Once the dividend amount becomes zero,the company will cease all dividends and go out of business.You have a required rate of return of 18 percent on this particular stock given the company's situation.What are your shares in this firm worth today on a per share basis?

Question

Quizplus · Accepted Answer

To calculate the present value of the stock after the first year, we need to use the Gordon Growth Model formula:
P0 = D1/(r-g)
where: 
D1= D0 x (1-g) = 2.80 x (1-0.25) = $2.10 (the dividend after one year)
r = required rate of return = 18%
g = growth rate = 25% (as the dividend is expected to decrease by 25% each year)

Substituting the values, we get:

P0 = 2.10/(0.18-0.25) = $4.88

Therefore, the shares in this firm are worth $4.88 per share today.

Sweatshirts Unlimited Is Downsizing