Answer:
PHASE 1
K = 16% = 0.16
V1 = D1 + D2 + D3
(1 + K) (1 + K)2 (1 + K)3
V1 = $0.62 + $0.80 + $1.05
(1 + 0. 16) (1 + 0.16)2 (1 + 0.16)3
V1 =$0.62 + $0.80 + $1.05
(1.16) (1.16)2 (1 .16)3
V1 = $0.53 + $0.59 + $0.67
V1 = $1.79
PHASE 2
g = 4% = 0.04
V2 = DN( 1 + g)
(Ke –g)(1+ K)n
V2 = $1.05(1 + 0.04)
(0.16 – 0.04)(1+ 0.16)3
V2 = 1.092
0.12 x 1.560896
V2 = 1.092
0.18730752
V2 = $5.83
Current market price
= V1 + V2
= $1.79 + $5.83
V2 = $7.62
The correct answer is A
Explanation:
In this case, there is need to decompose the current market price into two phases. In the first phase, dividends were given. The market price for this phase (V1) is a function of dividend in year 1 divided by 1 + k plus dividend in year 2 divided by 1 +k raised to power 2 plus dividend in year 3 divided by 1 + k raised to power 3. K represents the required return on stock.
In the second phase, the market price for this phase (V2) is a function of dividend paid in year 3, subject to the new growth rate of 4%, divided by 1+k multiplied by K-g raised to power 3. The Current market price is the aggregate of V1 and V2.
