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Evaluating the current price of the stock

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Tank Industries Washers expects to pay the following dividends over the next 4 years: $2.50, $3.20, $4.75 and $5.20 respectively (starting at time 1).

a. After year 4, the firm expects a constant growth rate of 3%. If investors require 11%, what is the current share price?

b. The CEO, Major Payne, has identified several new investment opportunities. He is trying to convince investors to back his strategy. He would need to keep the dividends at $2.50 each year for the next four years. After year 4, the growth rate would be 10% forever. Based on the increased risk, the other investors increase the required return to 15%. Should they back his strategy? Hint: Re-estimate the current price based on the new cash flows.

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Solution describes the steps to evaluate the current value of the stock in the given scenarios.

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a. After year 4, the firm expects a constant growth rate of 3%. If investors require 11%, what is the current share price?

Dividend at the end of year 1=D1=$2.50
Dividend at the end of year 2=D2=$3.20
Dividend at the end of year 1=D3=$4.75
Dividend at the end of year 1=D4=$5.20
Growth rate after 4th year=g=3%

Dividend at the end of year 1=D5=$5.20*(1+3%)=$5.356

Value of stock at the end of Year ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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