Stock Values. Integrated Potato Chips paid a $1 per share dividend
yesterday. You expect the dividend to grow steadily at a rate of 4
percent per year.

a. What is the expected dividend in each of the next 3 years?

b. If the discount rate for the stock is 12 percent, at what price
will the stock sell?

c. What is the expected stock price 3 years from now?

d. If you buy the stock and plan to hold it for 3 years, what payments
will you receive? What is the present value of those payments? Compare
your answer to (b).

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Request for Question Clarification by omnivorous-ga on 17 Jan 2005 09:44 PST

Stinkatfigures --

Are dividends paid quarterly?  Or annually?

Best regards,

Omnivorous-GA

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Clarification of Question by stinkatfigures-ga on 17 Jan 2005 16:24 PST

Dividends are paid annually.  Thanks for your help with this, I look
forward to your response!

a.  Given a growth rate, the expected dividend in years 1-3 is 1*1.04,
1*1.04^2, and 1*1.04^3, or, with rounding, 1.04, 1.08, and 1.12.

b.  P0 = DIV1/r-g (p. 62).  Therefore, Po = 1.04/(0.12 - 0.04) or 13.

c.  P3 = DIV4/r-g (p. 56).  Therefore, P3 = 1*1.04^4/(0.12 - 0.04) or 14.62.

d.  Payments = 1.04 + 1.08 + 1.12, or 3.24 (rounded).

PV of payments = 1.04/(1+0.12) + 1.08/(1+0.12)^2 + 1.12/(1+0.12)^3 or
2.59.  Therefore, the first three dividend payments comprise
essentially 20% of the total value of the stock.  This is because
future payments are worth less the farther off they are in the future,
even if they are assumed to be certain.

Source:  "Principles of Corporate Finance" 4th Edition by Brealey &
Myers, McGraw-Hill, Inc. (1991)

Sincerely,

Wonko

Thanks for the help, this is great!!