Consider the following stocks: • Stock A is expected to pay a dividend of £4 forever; • Stock B is expected to pay a dividend of £2 next year, £2.50 in year 2, with dividend growth expected to be 3% per annum thereafter. If the required return on similar equities is 9%, calculate the price of each stock.
Question
Answer:
£44.44
£40.06
Step-by-step explanation:
Stock A
Price of a perpetual dividend payment = dividend / required return
4 / 0.09 = 44.44
Stock B
price is equal to the present value of the dividend
Value in the second stage of constant growth =( 2.5 x 1.03) / (0.09 – 0.03) = 42.92
Cash flow in year 1 = 2
cash flow in year 2 = 2.5 + 42.92
I = 9%
PV = 40.06
To find the PV using a financial calculator:
1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.
2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.
3. Press compute