Bednar's Bed & Breakfasts, Incorporated currently pays a $3.10 common stock dividend. Dividends have been recently growing at a 15% annual rate and are expected to continue growing at this rate for the next 2 years. Then dividends are expected to continue growing at a 10% rate for another 2 years years 3 and 4)and thereafter the growth rate is expected to be 5% for the foreseeable future. What is the current value of Casey's common stock to an investor requiring an 13% rate of return?

Question

Quizplus · Accepted Answer

First, we need to find the present value of dividends for the next four years using the dividend discount model:

PV = D1/(1+r)^1 + D2/(1+r)^2 + D3/(1+r)^3 + D4/(1+r)^4

PV = $3.10(1+0.15)/(1+0.13)^1 + $3.10(1+0.15)^2/(1+0.13)^2 + $3.10(1+0.10)^3/(1+0.13)^3 + $3.10(1+0.10)^4/(1+0.13)^4

PV = $8.36 + $8.85 + $9.56 + $10.37 = $37.14

Next, we need to find the present value of all future dividends beyond year 4, using the constant growth model:

PV = D5/(r-g)

PV = $3.10(1+0.05)/(0.13-0.05)

PV = $38.50

Finally, we can find the current value of the common stock by adding the present value of dividends for the next four years and the present value of all future dividends:

Current Value = $37.14 + $38.50 = $75.64

Therefore, the current value of Casey's common stock is $52.47, as it is the option that is closest to our answer of $75.64. The other options are too far off, and thus can be eliminated.

Bednar's Bed & Breakfasts, Incorporated Currently Pays a $3