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Cellular Systems - Dividend Discount

Cellular Systems paid a $3 dividend last year. The dividend is expected to grow
at a constant rate of 5 percent over the next two years. The required rate of
return is 12 percent (this will also serve as the discount rate in this problem).
Round all values to three places to the right of the decimal point where
appropriate.
a. Compute the anticipated value of the dividends for the next three years.
That is, compute D1, D2, and D3; for example, D1 is $3.15 ($3.00  1.05).
Round all values throughout this problem to three places to the right of the
decimal point.
b. Discount each of these dividends back to the present at a discount rate of
12 percent and then sum them.
c. Compute the price of the stock at the end of the third year (P3).
P3 
(D4 is equal to D3 times 1.05)
d. After you have computed P3, discount it back to the present at a discount
rate of 12 percent for three years.
e. Add together the answers in part b and part d to get P0, the current value of
the stock. This answer represents the present value of the first three periods
of dividends, plus the present value of the price of the stock after three
periods (which, in turn, represents the value of all future dividends).
f. Use Formula 10-9 to show that it will provide approximately the same
answer as part e.
P0  (10-9)
For Formula 10-9 use D1  $3.15, Ke  12 percent, and g  5 percent.
(The slight difference between the answers to part e and part f is due to
rounding.)

Solution Preview

Cellular Systems paid a $3 dividend last year. The dividend is expected to grow
at a constant rate of 5 percent over the next two years. The required rate of
return is 12 percent (this will also serve as the discount rate in this problem).
Round all values to three places to the right of the decimal point where
appropriate.

a. Compute the anticipated value of the dividends for the next three years.
That is, compute D1, D2, and D3; for example, D1 is $3.15 ($3.00  1.05).
Round all values throughout this problem to three places to the right of the
decimal point.

The dividends over the three years would grow at ...

Solution Summary

The solution explains the use of dividend discount model to calculate the stock price, calculate dividends for future years and reconcile the future stock price with present value of dividends.

$2.19