Crystal Glass recently paid $3.60 as an annual dividend. Future dividends are projected at $3.80,...

Question:

Crystal Glass recently paid $3.60 as an annual dividend. Future dividends are projected at $3.80, $4.10, and $4.25 over the next 3 years, respectively. Beginning 4 years from now, the dividend is expected to increase by 3.25 percent annually.

What is one share of this stock worth to you if you require a 12.5 percent rate of return on similar investments?

Dividend growth model:

Dividend growth model is the model which gives the return or the price of the stock in case the company pays dividends perpetually with a constant growth rate. It follows the concept of present value of perpetuity.

Answer and Explanation:

As per Dividend Growth Model,

Price of the stock when perpetual dividend with constant growth starts = Next year dividend / (Return - Growth)

Now,

Constant growth starts after Year 3.

So,

Price at Year 3
= Dividend at Year 4 / (0.125 - 0.0325)
= (D3 x (1 + Growth)) / 0.0925
= 4.25 x 1.0325 / 0.0925
= $47.4392

Current price = Present value of all future dividends and the price at year 3

Present value of all future cash flows @ 12.5% is:

Year Total Benefits (a) Discounting Factor (b ) = (1/1+r)^n P.V. (c ) = (axb)
0 - 1.0000 -
1 3.80 0.8889 3.38
2 4.10 0.7901 3.24
3 51.69 0.7023 36.30
SUM (PV) 42.92

So,

Current price = $42.92


Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
9.8K

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