Question

1. Stock Values. Integrated Potato Chips paid a $2 per share dividend yesterday. You expect the dividend to grow steadily at a rate of 4 percent per year. a. What is the expected dividend in each of the next 3 years? b. If the discount rate for the stock is 12 percent, at what price will the stock sell? c. What is the expected stock price 3 years from now? d. If you buy the stock and plan to hold it for 3 years, what payments will you receive? What is the present value of those payments? Compare your answer to (b).

Answer 1

Answer and Explanation:

The computation of each point is shown below:-

a. Expected dividend in each of the next 3 years is

Dividend in year 1 = Current Dividend × (1 + growth rate)

= 2 × (1 + 0.04)

= 2.08

Dividend in year 2 = Dividend in year 1 × (1 + growth rate)

= 2.08 × (1 + 0.04)

= 2.1632

Dividend in year 3 = Dividend in year 2 × (1 + growth rate)

= 2.1632 × (1 + 0.04)

= 2.249728

b Price the stock will sell

Current Price = Dividend in year 1 ÷ (Discount rate - growth rate)

= 2.08 ÷ (0.12 - 0.04)

= 26

c. Expected Price 3 years from now is

Price in Year 3 = Dividend in year 4 ÷ (Discount rate - growth rate)

= [2 × (1 + 0.04)^4] ÷ (0.12 - 0.04)

= 2.33971712 ÷ 0.08

= 29.246464

d. The present value of payments received is

Year Dividend ÷ Price PVF at 12% Present Value of Dividend ÷ Price

0 2 1

1 Dividend 2.08 0.892857143 1.857142857

2 Dividend 2.1632 0.797193878 1.724489796

3 Dividend 2.249728 0.711780248 1.601311953

3 Price at

year 3 29.246464 0.711780248 20.81705539

Total 26

Note

Here the present value is the same as we have calculated in part b.