Business Finance Answers_Part_38

Business Finance Answers_Part_38 - CHAPTER 8 B-149 b If the...

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CHAPTER 8 B-149 b . If the company pays quarterly dividends instead of annual dividends, the quarterly dividend will be one-fourth of annual dividend, or: Quarterly dividend: $3.20(1.06)/4 = $0.848 To find the equivalent annual dividend, we must assume that the quarterly dividends are reinvested at the required return. We can then use this interest rate to find the equivalent annual dividend. In other words, when we receive the quarterly dividend, we reinvest it at the required return on the stock. So, the effective quarterly rate is: Effective quarterly rate: 1.12 .25 – 1 = .0287 The effective annual dividend will be the FVA of the quarterly dividend payments at the effective quarterly required return. In this case, the effective annual dividend will be: Effective D 1 = $0.848(FVIFA 2.87%,4 ) = $3.54 Now, we can use the constant growth model to find the current stock price as: P 0 = $3.54/(.12 – .06) = $59.02 Note that we cannot simply find the quarterly effective required return and growth rate to find the value of the stock. This would assume the dividends increased each quarter, not each year. 24. Here we have a stock with supernormal growth, but the dividend growth changes every year for the first four years. We can find the price of the stock in Year 3 since the dividend growth rate is constant after the third dividend. The price of the stock in Year 3 will be the dividend in Year 4, divided by the required return minus the constant dividend growth rate. So, the price in Year 3 will be: P 3 = $2.45(1.20)(1.15)(1.10)(1.05) / (.11 – .05) = $65.08
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