Google Answers Logo
View Question
Q: Stock Values ( Answered,   0 Comments )
Subject: Stock Values
Category: Business and Money > Finance
Asked by: jimson5681-ga
List Price: $10.00
Posted: 04 Aug 2005 13:08 PDT
Expires: 03 Sep 2005 13:08 PDT
Question ID: 551766
This is my first post here and I am trying to complete this assignment
but my instructor never really spent any time on this subject. Can
someone assist me with this question below.

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).
Subject: Re: Stock Values
Answered By: omnivorous-ga on 04 Aug 2005 13:58 PDT
Jimson5681 --

A. Dividends today are D0 = $1 per share.

Dividend at the end of year 1 = $1 * 1.04 = $1.04
(You?ll use 0.04 for 4 percent; 0.12 for 12%
Year 2 = (1.04) ^2 = $1.08
Year 3 = (1.04 ^3 = $1.12

B. The general model for stock pricing looks like this:

Pi = Di / (r-g)

Pi = price in period i
Di = dividends in period i
r = required rate of return (in decimals)
g = dividend growth rate
i = period, usually expressed in years

P0 = $1 / (0.12 ? 0.04) = $1 / (0.08) = ?

C. You can use the same formula to figure the stock price in year 3 ?
it?s P3.  Just make sure that you adjust D0 to D3 ? as your dividends
have grown.

So, it?s 

P3 = $1.12 / (0.12 ? 0.04) = $1.12/(0.08) = ?  (hint: it?s bigger!)

D.	First let?s do each year?s cash flows ? and don?t forget that
you?re spending money up front (that?s negative cash flow) -- but the
other returns are positive:

Year 0: -$12.50
Year 1: $1.04
Year 2: $1.08
Year 3: $1.12 + $14.00 (that?s the answer to C, $14)

NPV factor is figured by dividing $1 worth of value by the (1 + i)^t,
where i = discount rate and t = time (in years) that has passed.  For
stock bought today, t = 0 and the NPV factor is $1.

Phrased differently, $1 today is worth $1 ? but in a year it?s
depreciated by 12% and so it?s worth $1/(1.12)^1 = 0.8929.

If you?ll be doing these NPV calculations often, the smoothest way to
handle it is to set up your NPV factors in a specific line because it
simplifies complicated cash flow analyses.  It also allows you to
check your NPV calculations and quickly spot errors if the number's
not declining as it seems it should.

So here are your NPV factors:

Year 0 (today): 1
Year 1: 0.8929
Year 2: 1/(1.12)^2 = 0.7972
Year 3: 1/(1.12)^3 = 0.7118

The discounted cash flow becomes: 

Year 0: -$12.50
Year 1: $1.04 * 0.8929 = $0.93
Year 2: $1.08 * 0.7972 = $0.86
Year 3: $15.12 = $10.76


That?s not much money to make on a $12.50 investment.  In fact, it?s
effectively zero ? and if we hadn?t rounded 8 different calculations
of dividends and NPV, it would be zero.

Why?  It?s because the stock has been priced with future cash flows
and earnings growth in mind ? and with a 12% discount rate.  Holding
the stock will become more profitable only if dividends grow faster in
the 3-year period ? or if the discount rate declines.

Let us know via a Clarification Request, if any portion of this doesn?t make sense.

Best regards,

There are no comments at this time.

Important Disclaimer: Answers and comments provided on Google Answers are general information, and are not intended to substitute for informed professional medical, psychiatric, psychological, tax, legal, investment, accounting, or other professional advice. Google does not endorse, and expressly disclaims liability for any product, manufacturer, distributor, service or service provider mentioned or any opinion expressed in answers or comments. Please read carefully the Google Answers Terms of Service.

If you feel that you have found inappropriate content, please let us know by emailing us at with the question ID listed above. Thank you.
Search Google Answers for
Google Answers  

Google Home - Answers FAQ - Terms of Service - Privacy Policy