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DC Motors recently paid $1.10 as its annual dividend. Future dividends are projected at $1.06, $1.02, and $1.00 over the next three years, respectively. After that, the dividend is expected to decrease by 2 percent annually. What is one share of this stock worth at a rate of return of 17 percent?

Answer :

Answer:

$5.50

Explanation:

For computing the value of stock, first we have to determine the dividend at the end of the third year which is shown below:

= last year dividend × (1 + growth rate) ÷ (cost of capital - growth rate)  

= $1 × ( 1 - 0.02) ÷ (0.17 +0.02)

= $0.98 ÷ 0.19

= $5.16

The computation of the value of stock is shown below:

Year Dividend         Present value factor at 17%          Present value  

1          $1.06              0.8547                                               $0.91              

2         $1.02              0.7305                                               $0.75  

3          $1                   0.6244                                               $0.62          

3          $5.16             0.6244                                               $3.22

Total present value                                                            $5.50

The present value factor is computed below:

= 1 ÷ (1 + rate) ^ years

For Year 1 = 1 ÷ 1.17^1 = 0.8547    

For Year 2 = 1 ÷ 1.17^2 = 0.7305      

For Year 3 = 1 ÷ 1.17^2 = 0.6244        

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