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John's Catering is growing at a very fast rate. As a result, the company expects to increase its...

Question:

John's Catering is growing at a very fast rate. As a result, the company expects to increase its dividend to $0.45, $0.95, $1.60, and $2.15 over the next four years, respectively. After that, the dividend is projected to increase by 6 percent annually. The last annual dividend the firm paid was $.30 share.

What is the current value of this stock if the required return is 17 percent?

Dividend Discount Model:

According to the dividend discount model, the price of a stock is the discounted present value of future dividends. The challenge when applying this model in practice is the difficulty of forecasting future dividend streams from a firm with reasonable accuracy.

Answer and Explanation:

According to the dividend discount model, the price of the stock is the discounted present value of its future dividends, i.e.,

  • {eq}\dfrac{0.45}{(1 + 17\%)} + \dfrac{0.95}{(1 + 17\%)^2} + \dfrac{1.60}{(1 + 17\%)^3} + \dfrac{1.25}{(1 + 17\%)^4} + \dfrac{2.15*(1 + 6\%)}{(17\% - 6\%)(1 + 17\%)^4}\\ = 0.38 + 0.69 + 1 + 1.15 + 11.05\\ = 14.27 {/eq}

That is, the current price of the stock is $14.27.


Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
10K

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