Reference no: EM132674828

A firm paid a $4 dividend last year. The dividend is expected to grow at a constant rate of 6 % over the next four years. The required rate of return is 13 % (this will also serve as the discount rate in this problem). Round all values to three places to the right of the decimal point where appropriate.

a. Compute the anticipated value of the dividends for the next four years. That is, compute D1, D2, D3, and D4; for example, D1 is $4.24 ($4 × 1.06).

b. Discount each of these dividends back to present at a discount rate of 13 % and then sum them.

c. Compute the price of the stock at the end of the fourth year (P4). (D5 is equal to D4 times 1.06)

d. After you have computed P4, discount it back to the present at a discount rate of 13 % for four years.

e. Add together the answers in part b and part d to get P0, the current value of the stock. This answer represents the present value of the four periods of dividends, plus the present value of the price of the stock after four periods, (which, in turn, represents the value of all future dividends).

f. Use Formula to show that it will provide approximately the same answer as part e. D1 = $4.24, rs = 13 %, and g = 6 %. (The slight difference is due to rounding.)

g. If current EPS were $5.70 and P/E ratio is 1.2 times higher than industry's 9, what is stock price?

h. By what dollar amount is the stock price in part g different from the stock price in part f?

i. In f, indicate which direction price would move if (1) D1 increases, (2) rs increases, (3) g increases.