Concept explainers
Stock Valuation [LO1] Bayou Okra Farms just paid a dividend of $2.65 on its stock. The growth rate in dividends is expected to be a constant 4.5 percent per year indefinitely. Investors require a return of 15 percent for the first three years, a return of 13 percent for the next three years, and a return of 11 percent thereafter. What is the current share price?
To determine: The current price of the share.
Introduction:
Stock price is a price of a share on the number of saleable stock of a company.
Answer to Problem 14QP
Explanation of Solution
Given information:
BO Company has currently paid dividends of $2.65. The constant growth rate of dividends is 4.5%. The investor’s required rate of return for the first three years is 15%, for the next three years is 13%, and a return of 11% for subsequent years.
Formulae:
Formula to calculate the stock price of Year 6:
Where,
P6 refers to the price of stock in 6 years
Do refers to the dividend paid presently
R refers to the required return on the stock
g refers to the constant growth rate
n refers to the number of years
Note: The dividend value of Year 7 is computed to determine the price of stock in Year 6.
Formula to calculate the stock price of Year 3:
Where,
P3 refers to the price of the stock in Year 3
D1…Dn refers to the next period expected dividend per share
R refers to the required rate of return on its stock
g refers to the constant growth rate
Note: At the time when the required return changes frequently, then the stock price in Year 3 is the present value of the dividends in Year 4, Year 5, and Year 6 plus the present value of stock of Year 3.
Formula to calculate the current price of the share:
Where,
Po refers to the present price of stock
D1…Dn refers to the next period expected dividend per share
R refers to the required return on the stock
g refers to the constant growth rate
Compute the stock price of Year 6:
Hence, the stock price of Year 6 is $55.48.
Compute the stock price of Year 3:
Hence, the stock price of Year 6 is $46.58.
Compute the current price of the share:
Hence, the current price of the share is $37.21.
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Chapter 8 Solutions
Fundamentals of Corporate Finance (Special Edition for Rutgers Business School)
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