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 two 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 $2.80 a share. What is one share of this stock worth today?

Question

Quizplus · Accepted Answer

The stock price today is calculated using the dividend discount model. First, calculate the dividends for the next two years with a 10% decrease: D1 = $2.80 * 0.9 = $2.52, D2 = $2.52 * 0.9 = $2.268. Then, calculate the price at the end of year 2 using the constant growth formula: P2 = D3 / (required return - growth rate) = ($2.268 * 1.05) / (0.14 - 0.05) = $26.544. Finally, calculate the present value of these cash flows: P0 = D1 / (1 + 0.14) + D2 / (1 + 0.14)^2 + P2 / (1 + 0.14)^2 = $2.52 / 1.14 + $2.268 / 1.2996 + $26.544 / 1.2996 = $24.32.

Ultra Fine Furnishings Is in the Process of Selling Its