USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8 percent per year for the next five years. After that dividends are expected to grow at a normal rate of 5 percent per year. Assume that the appropriate discount rate is 7 percent.
-Refer to Exhibit 8.3. The present value today of dividends for years 1 to 5 is
A) $4.06.
B) $10.28.
C) $12.40.
D) $14.52.
E) $10.0.

Question

Quizplus · Accepted Answer

To calculate the present value of dividends for years 1 to 5, we use the formula for the present value of a growing annuity. The dividends grow at 8% for the first five years. The dividend for the first year is $2 * (1 + 0.08) = $2.16. Using the formula for the present value of a growing annuity, we calculate the present value of these dividends, discounted back at the 7% discount rate. The calculation yields a present value of approximately $10.28 for the dividends from years 1 to 5.