Solved Question: Dividend Discount Model. Integrated Potato Chips just paid a $1 per share dividend

Get premium Solution to all your Homework Assignments exclusively on writerkingdom. We have CFA/MBA writers to provide customized model answers to your every academic problem

Compare

Description

Question:

Dividend Discount Model. Integrated Potato Chips just paid a $1 per share dividend.

You expect the dividend to grow steadily at a rate of 4% per year. (LO7-2)

a. What is the expected dividend in each of the next 3 years?

b. If the discount rate for the stock is 12%, at what price will the stock sell?

c. What is the expected stock price 3 years from now?

d. If you buy the stock and plan to sell it 3 years from now, what are your expected cash flows in (i) year 1; (ii) year 2; (iii) year 3?

e. What is the present value of the stream of payments you found in part (d)? Compare your answer to part (b).

Answer:

a. Expected dividend in next three years:

Dividend growth rate=4%=0.04

D1=Expected dividend next year=1*(1+0.04)=$1.04

D2=Expected dividend in year 2=D1*1.04=$1.0816

D3=Expected dividend in year3=D2*1.04=$1.124864

.b Discount rate=12%=0.12

Market price of the share=D1/(R-g)

R=Discount rate=0.12

g=Dividend growth rate=0.04

Market Price of Share=1.04/(0.12-0.04)=$13

.c. Expected stock price after three years=P3=D4/(R-g)

D4=D3*1.04=$1.169859

Stock price after 3 years=P3=1.169859/(0.12-0.04)=$14.62323

.d. (i)Cash flow in year 1= Dividend D1=$1.04

(ii)Cash flow in year2=Dividend D2=$1.0816

(iii)Cash flow in year 3 =D3+P3=1.124864+14.62323=$15.7481

.e. Present value of stream of cash flows=(1.04/1.12)+(1.0816/(1.12^2))+15.7481/(1.12^3)

Present value of stream of cash flows=$13.00

The amount is same as present market price of share calculated under .b ie $13

Reviews

There are no reviews yet.

Be the first to review “Solved Question: Dividend Discount Model. Integrated Potato Chips just paid a $1 per share dividend”

Your email address will not be published. Required fields are marked *