Question

Flash Freeze Frozen Foods is expected to pay annual dividends of $1.34 and $1.45 at the end of the next two years, respectively. After that, the company expects to pay a constant dividend of $1.50 a share. What is the value of this stock at a required return of 15.1 percent?

Answer 1

To calculate the value of a stock using the dividend discount model (DDM), we can use the constant growth DDM formula. Plugging in the given values, the value of the stock is $9.93.

Step-by-step explanation:

To calculate the value of a stock, we can use the dividend discount model (DDM). DDM values a stock by discounting all future expected dividends back to their present value. In this case, we will use the constant growth DDM formula as the company is expected to pay a constant dividend after the first two years.

Using the constant growth DDM formula, the value of the stock can be calculated as: Value = D1 / (r - g), where D1 is the dividend at the end of the first year, r is the required return, and g is the constant growth rate. In this question, the dividends for the first two years are given, and the constant growth rate is assumed to be 0% as the dividends are expected to remain constant after the second year.

Plugging in the values into the formula, we get: Value = $1.50 / (0.151 - 0). Simplifying, we get: Value = $9.93.

Answer 2

The value of a share of stock in Babble, Inc., given the expected dividends and a required return of 15.1%, would be $256,286.02. This is calculated by discounting the expected future dividends to their present value and summing them up.

Step-by-step explanation:

If we consider Babble, Inc., a hypothetical company that offers speaking lessons, is expected to pay dividends that equal the company's profits because it will be disbanded in two years. To calculate the value of a share of stock, we must discount the expected dividends to the present value using the required rate of return. With an expected profit of $15 million immediately, $20 million in one year, and $25 million in two years, and with 200 shares of stock, the dividends per share would be:

• $15 million / 200 shares = $75,000 per share immediately,
• $20 million / 200 shares = $100,000 per share in one year,
• $25 million / 200 shares = $125,000 per share in two years.

To find the present value of these dividends, we apply the formula for the present value of a future payment:

Present Value = Future Payment / (1 + r)^n

where r is the required rate of return and n is the number of years until payment. Assuming a required return of 15.1%, the present value (PV) of dividends per share is:

1. PV of immediate dividend: $75,000
2. PV of first year dividend: $100,000 / (1 + 0.151) = $86,879.41
3. PV of second year dividend: $125,000 / (1 + 0.151)^2 = $94,406.61

To find the total present value, we add these amounts:

$75,000 + $86,879.41 + $94,406.61 = $256,286.02

Therefore, an investor would be willing to pay $256,286.02 per share for stock in Babble, Inc., considering the expected dividends and the required rate of return.