Bread, Inc., has an odd dividend policy. The company has just paid a dividend of $6 per share and has announced that it will increase the dividend by $4 per share for each of the next five years, and then never pay another dividend. If you require an 11 percent return on the companys stock, how much will you pay for a share today? The price of a stock is the PV of the future dividends. This stock is paying four dividends, so the price of the stock is the PV of these dividends using the required return. The price of the stock is: P = $10 / 1.11 + $14 / 1.11 2 + $18 / 1.11 3 + $22 / 1.11 4 + $26 / 1.11 5 = $63.45
Example 8.
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Get Help Now!Marcel Co. is growing quickly. Dividends are expected to grow at a 30 percent rate for the next three years, with the growth rate falling off to a constant 6 percent thereafter. If the required return is 13 percent and the company just paid a $1.80 dividend, what is the current share price? With supernormal dividends, we find the price of the stock when the dividends level off at a constant growth rate, and then find the PV of Example the futures stock price, plus the PV of all dividends during the supernormal growth period. The stock begins constant growth in Year 4, so we can find the price of the stock in Year 3, one year before the constant dividend growth begins as: P 3 = D 3 (1 + g ) / ( R g ) = D (1 + g 1 ) 3 (1 + g 2 ) / ( R g ) P 3 = $1.80(1.30) 3 (1.06) / (.13 .06) P 3 = $59.88
Example
The price of the stock today is the PV of the first three dividends, plus the PV of the Year 3 stock price. The price of the stock today will be: P = $1.80(1.30) / 1.13 + $1.80(1.30) 2 / 1.13 2 + $1.80(1.30) 3 / 1.13 3 + $59.88 / 1.13 3 P = $48.70
Example
Antiques R Us is a mature manufacturing firm. The company just paid a $10.46 dividend, but management expects to reduce the payout by 4 percent per year indefinitely. If you require an 11.5 percent return on this stock, what will you pay for a share today?
The constant growth model can be applied even if the dividends are declining by a constant percentage, just make sure to recognize the negative growth.
So, the price of the stock today will be: Example P = D (1 + g ) / ( R g ) P = $10.46(1 .04) / [(.115 (.04)] P = $64.78…
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