# Evaluate dividends

1) A stock you are evaluating just paid an annual dividend of $2.50. Dividends have grown at a constant rate of 1.5% over the last 15 years and you expect this to continue.

a. If the required rate of return on the stock is 12% what is its fair present market value?

b. If the requested rate of return on the stock is 15% what is its expected price four years from today?

2) You are considering the purchase of a stock that is currently selling at $64 per share. You expect the stock to pay $4.50 in dividends next year.

a) If the dividend are expected to grow at a constant rate of 3% per year what is your expected rate of return on this stock?

b) If the dividend are expected to grow at a constant rate of 5% per year what is your expected rate of return on this stock?

c) What do your answers in parts a and b tell you about the impact of dividend growth rates on expected rate of returns?

3) A stock that you are evaluating is expected to experience supernormal growth In dividends of 8% over the next six years. Following this period, dividends are expected to grow at a constant rate of 3. The stock paid a dividend of $5.50 last year and the required rate of return on the stock is 10%. Calculate the stocks fair present market value.

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#### Solution Preview

We use the ddm to value the stocks in all three questions. The ddm says that price = dividend/(required return - growth rate).

1.

a) price = 2.5/(0.12-0.015) = 23.81

b) In 4 years from today, the dividend will be 2.5 X 1.015^4 = 2.65.

So, by ddm, it will be worth 2.65/(0.15 - 0.015) = 19.63. This value is expressed in the money 4 years from today.

To see how much it will be worth in present terms, we discount it 19.63/1.15^4 = 11.22.

So the stocks price in 4 year from ...

#### Solution Summary

Evaluate dividends: required rate of return, expected growth rate, present market value