Yesteryear Productions pays no dividend at the present time. The company plans to start paying an annual dividend in the amount of $0.40 a share for two years commencing four years from today. After that time, the company plans on paying a constant $0.75 a share annual dividend indefinitely. How much are you willing to pay to buy a share of this stock today if your required return is 11.6 percent?
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This problem is asking you to compute the current price of a stock, which will be expected to pay dividends from year 4 forwards.
The best way to start is figuring out a time line for the dividends, until the constant, indefinite dividend years begin. Then we calculate the present value (PV) of the dividends (years 4 and 5). Finally we compute the present value of the constant dividends, also called the terminal value or the horizon value.
Year Div. PV of Div
1 0 0
2 0 0
3 0 0
The payment purchases price of stocks are examined.