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Dividend Discount Model

1. The Club Auto Parts Company has just recently been organized. It is expected to experience no growth for the next 2 years as it identifies its market and acquires its inventory. However, Club will grow at an annual rate of 5% in the third year and, beginning with the fourth year, should attain a 10% growth rate that it will sustain thereafter. The first divident to be paid at the end of the first year is expected to be $0.50 per share. Investors require a 15% rate of return on Club's stock. What is the current equilibrium stock price?

2. Johnson Corporation's stock is currently selling at $45.83 per share. The last dividend paid was $2.50. Johnson is a constant growth firm. If investors require a return of 16% on Johnson's stock, what do they think Johnson's growth rate will be?

3. Assume that the average firm in your company's industry is expected to grow at a constant rate of 7% and its dividend yield is 8%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R&D work that leads you to expect you to expect that its earnings and dividends will grow at a rate of 40% this year and 20% the following year, after which growth should match the 7% industry average rate. The last dividend paid was $1. What is the current value per share of your firm's stock?

4. Hanebury Manufacturing Company has preferred stock outstanding with a par value of $50. The stock pays a quarterly dividend of $1.25 and has a current price of $71.43. What is the nominal rate of return on the preferred stock?

Solution Preview

1. The Club Auto Parts Company has just recently been organized. It is expected to experience no growth for the next 2 years as it identifies its market and acquires its inventory. However, Club will grow at an annual rate of 5% in the third year and, beginning with the fourth year, should attain a 10% growth rate that it will sustain thereafter. The first divident to be paid at the end of the first year is expected to be $0.50 per share. Investors require a 15% rate of return on Club's stock. What is the current equilibrium stock price?

We have to use the dividend discount model to arrive at the price. Since there are three period of growth, the dividends will be as per the details below :
Year 1 Year 2 Year 3 Year 4 Year 5
Dividend 0.50 0.50 0.525 0.5775 0.63525
Growth Rate 0 ...

Solution Summary

The solution explains calculation of stock price, growth rate using the dividend discount model. It also has calculation for return on a preferred stock

$2.19