Combined Communications is a new firm in a rapidly growing industry.The company is planning on increasing its annual dividend by 15 percent a year for the next 4 years and then decreasing the growth rate to 3.5 percent per year.The company just paid its annual dividend in the amount of $0.20 per share.What is the current value of one share of this stock if the required rate of return is 15.5 percent?
A)$1.82
B)$2.04
C)$2.49
D)$2.71
E)$3.05

Question

Quizplus · Accepted Answer

To calculate the current value of a share, we use the dividend discount model:

Current stock price = Dividend / (Required rate of return - Growth rate)

For the first four years, the growth rate is 15%, and then it drops to 3.5%. We can use the formula to calculate the current stock price:

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%) = $0.35
Year 5 (and beyond): $0.35 x (1 + 3.5%)

Now we can plug in these values to get the stock price:

Current stock price = $0.23/(0.155 - 0.15) + $0.26/(0.155 - 0.15)^2 + $0.30/(0.155 - 0.15)^3 + $0.35/(0.155 - 0.15)^4 + $0.35/(0.155 - 0.035)^5

Solving this equation, we get a current stock price of $2.49. Therefore, the best choice is C.

Combined Communications Is a New Firm in a Rapidly Growing