Global Tek plans on increasing its annual dividend by 15 percent a year for the next four years and then decreasing the growth rate to 2.5 percent per year. The company just paid its annual dividend in the amount of $.20 per share. What is the current value of one share of this stock if the required rate of return is 17.4 percent?
A) $1.82
B) $2.18
C) $2.03
D) $2.71
E) $3.05

Question

Quizplus · Accepted Answer

First, we need to calculate the expected dividends for the next four years:

Year 1: $0.20 x 1.15 = $0.23
Year 2: $0.23 x 1.15 = $0.26
Year 3: $0.26 x 1.15 = $0.30
Year 4: $0.30 x 1.15 = $0.34

After the fourth year, the annual dividend growth rate would be 2.5 percent, so we can calculate the expected dividend for Year 5:

Year 5: $0.34 x 1.025 = $0.35

Next, we need to calculate the present value of these expected dividends. We will use the dividend discount model:

P0 = (D1 / (1 + r)1) + (D2 / (1 + r)2) + ... + (Dn / (1 + r)n)

where:
P0 = current stock price
D1, D2, ..., Dn = expected dividends in each year
r = required rate of return
n = number of years

Plugging in the values, we get:

P0 = ($0.23 / (1 + 0.174)1) + ($0.26 / (1 + 0.174)2) + ($0.30 / (1 + 0.174)3) + ($0.34 / (1 + 0.174)4) + ($0.35 / (1 + 0.174)5)

P0 = $0.186 + $0.188 + $0.194 + $0.198 + $0.170

P0 = $0.936

Therefore, the current value of one share of this stock is $0.936 or approximately $2.03. The closest answer choice is C.

Global Tek Plans on Increasing Its Annual Dividend by 15