Aa 10

1. Here we have a stock that pays no dividends for 9 years.
Once the stock begins paying dividends, it

will have a constant growth rate of dividends. We can use the constant growth model at that point. It is
important to remember that the general form of the constant dividend growth formula is:
Pt = [Dt × (1 + g)] / (R – g)
This means that since we will use the dividend in Year 10, we will be finding the stock price in Year 9.
The dividend growth model is similar to the PVA and the PV of a perpetuity: The equation gives you
the PV one period before the first payment. So, the price of the stock in Year 9 will be:
P9 = D10 / (R – g) = $15.00 / (.13 – .055) = $200

The price of the stock today is simply the PV of the stock price in the future. We simply discount the
future stock price at the required return. The price of the stock today will be:
P0 = $200 / 1.139 = $66.58
2. The price of a stock is the PV of the future dividends. This stock is paying five dividends, so the price
of the stock is the PV of these dividends using the required return. The price of the stock is:
P0 = $15 / 1.12 + $18 / 1.122 + $21 / 1.123 + $24 / 1.124 + $27 / 1.125 = $73.26
3. With differential dividends, we find the price of the stock when the dividends level off at a constant
growth rate, and then find the PV of the future stock price, plus the PV of all dividends during the
differential growth period. The stock begins constant growth in Year 5, so we can find the price of the
stock in Year 4, one year before the constant dividend growth begins, as:
P4 = D4 (1 + g) / (R – g) = $2.75(1.05) / (.13 – .05) = $36.09
The price of the stock today is the PV of the first four dividends, plus the PV of the Year 4 stock price.
So, the price of the stock today will be:
P0 = $10 / 1.13 + $7 / 1.132 + $6 / 1.133 + ($2.75 + 36.09) / 1.134 = $42.31
4. With differential dividends, we find the price of the stock when the dividends level off at a constant
growth rate, and then find the PV of the future stock price, plus the PV of all dividends during the
differential growth period. The stock begins constant growth in Year 4, so we can find the price of the
stock in Year 3, one year before the constant dividend growth begins as:
P3 = D3 (1 + g) / (R – g) = D0 (1 + g1)3 (1 + g2) / (R – g2) = $2.80(1.20)3(1.05) / (.12 – .05) = $72.58
The price of the stock today is the PV of the first three dividends, plus the PV of the Year 3 stock
price. The price of the stock today will be:
P0 = $2.80(1.20) / 1.12 + $2.80(1.20)2 / 1.122 + $2.80(1.20)3 / 1.123 + $72.58 / 1.123

P0 = $61.32
5. Here we need to find the dividend next year for a stock experiencing differential growth. We know the
stock price, the dividend growth rates, and the required return, but not the dividend. First, we need to
realize that the dividend in Year 3 is the current dividend times the FVIF. The dividend in Year 3 will
be:
D3 = D0 (1.30)3
And the dividend in Year 4 will be the dividend in Year 3 times one plus the growth rate, or:
D4 = D0 (1.30)3 (1.18)
The stock begins constant growth after the 4 th dividend is paid, so we can find the price of the stock in
Year 4 as the dividend in Year 5, divided by the required return minus the growth rate. The equation
for the price of the stock in Year 4 is:
P4 = D4 (1 + g) / (R – g)
Now we can substitute the previous dividend in Year 4 into this equation as
follows: P4 = D0 (1 + g1)3 (1 + g2) (1 + g3) / (R – g3)
P4 = D0 (1.30)3 (1.18) (1.08) / (.11 – .08) = 93.33D0
When we solve this equation, we find that the stock price in Year 4 is 93.33 times as large as
the dividend today. Now we need to find the equation for the stock price today. The stock price
today is the PV of the dividends in Years 1, 2, 3, and 4, plus the PV of the Year 4 price. So:
P0 = D0(1.30)/1.11 + D0(1.30)2/1.112 + D0(1.30)3/1.113+ D0(1.30)3(1.18)/1.114 + 93.33D0/1.114
We can factor out D0 in the equation, and combine the last two terms. Doing so,
we get: P0 = $65.00 = D0{1.30/1.11 + 1.302/1.112 + 1.303/1.113 + [(1.30)3(1.18) +
93.33] / 1.114}
Reducing the equation even further by solving all of the terms in the braces, we get:
$65 = $67.34D0
D0 = $65.00 / $67.34 = $.97
This is the dividend today, so the projected dividend for the next year
will be: D1 = $.97(1.30) = $1.25
6. The constant growth model can be applied even if the dividends are declining by a constant
percentage, just make sure to recognize the negative growth. So, the price of the stock today
will be:
P0 = D0 (1 + g) / (R – g) = $9(1 – .04) / [(.11 – (–.04)] = $57.60
7. We are given the stock price, the dividend growth rate, and the required return, and are asked
to find the dividend. Using the constant dividend growth model, we get:
P0 = $58.32 = D0 (1 + g) / (R – g)
Solving this equation for the dividend gives us:
D0 = $58.32(.115 – .05) / (1.05) = $3.61
8. The price of a share of preferred stock is the dividend payment divided by the required return.
We know the dividend payment in Year 5, so we can find the price of the stock in Year 4, one
year before the first dividend payment. Doing so, we get:
P4 = $8.00 / .056 = $142.86
The price of the stock today is the PV of the stock price in the future, so the price today
will be: P0 = $142.86 / (1.056)4 = $114.88

Aa 10

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1. Here we have a stock that pays no dividends for 9 years.

Once the stock begins paying dividends, it

P9 = D10 / (R – g) = $15.00 / (.13 – .055) = $200

P0 = $200 / 1.139 = $66.58

P4 = D4 (1 + g) / (R – g) = $2.75(1.05) / (.13 – .05) = $36.09

P0 = $10 / 1.13 + $7 / 1.132 + $6 / 1.133 + ($2.75 + 36.09) / 1.134 = $42.31

P3 = D3 (1 + g) / (R – g) = D0 (1 + g1)3 (1 + g2) / (R – g2) = $2.80(1.20)3(1.05) / (.12 – .05) = $72.58

P0 = $2.80(1.20) / 1.12 + $2.80(1.20)2 / 1.122 + $2.80(1.20)3 / 1.123 + $72.58 / 1.123

follows: P4 = D0 (1 + g1)3 (1 + g2) (1 + g3) / (R – g3)

P4 = D0 (1.30)3 (1.18) (1.08) / (.11 – .08) = 93.33D0

P0 = D0(1.30)/1.11 + D0(1.30)2/1.112 + D0(1.30)3/1.113+ D0(1.30)3(1.18)/1.114 + 93.33D0/1.114

we get: P0 = $65.00 = D0{1.30/1.11 + 1.302/1.112 + 1.303/1.113 + [(1.30)3(1.18) +

D0 = $65.00 / $67.34 = $.97

will be: D1 = $.97(1.30) = $1.25

P0 = D0 (1 + g) / (R – g) = $9(1 – .04) / [(.11 – (–.04)] = $57.60

Solving this equation for the dividend gives us:

D0 = $58.32(.115 – .05) / (1.05) = $3.61

P4 = $8.00 / .056 = $142.86

will be: P0 = $142.86 / (1.056)4 = $114.88

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