Hot Wings, Inc., has an odd dividend policy. The company has just paid a dividend of $11.25 per share and has announced that it will increase the dividend by $9.25 per share for each of the next four years, and then never pay another dividend.
Required:
If you require a 13 percent return on the company’s stock, how much will you pay for a share today
Ans-98.06
To calculate how much you should pay for a share today, you need to determine the present value of the expected future dividends. Here's how you can calculate it:
1. Determine the future dividends: The dividend for the next four years will increase by $9.25 per share each year, starting from the initial dividend of $11.25.
- Year 1 dividend = $11.25 + $9.25 = $20.50 per share
- Year 2 dividend = $20.50 + $9.25 = $29.75 per share
- Year 3 dividend = $29.75 + $9.25 = $39.00 per share
- Year 4 dividend = $39.00 + $9.25 = $48.25 per share
2. Determine the present value of each dividend: To calculate the present value of each future dividend, you need to discount them back to their present value using the required rate of return, which is 13 percent or 0.13.
- Present value of Year 1 dividend = $20.50 / (1 + 0.13)^1 = $18.14 per share
- Present value of Year 2 dividend = $29.75 / (1 + 0.13)^2 = $23.26 per share
- Present value of Year 3 dividend = $39.00 / (1 + 0.13)^3 = $26.52 per share
- Present value of Year 4 dividend = $48.25 / (1 + 0.13)^4 = $27.05 per share
3. Calculate the present value of the expected future dividends:
- PV of expected future dividends = Present value of Year 1 dividend + Present value of Year 2 dividend + Present value of Year 3 dividend + Present value of Year 4 dividend
- PV of expected future dividends = $18.14 + $23.26 + $26.52 + $27.05 = $94.97 per share
Therefore, you should pay approximately $94.97 for a share of Hot Wings, Inc. today if you require a 13 percent return on the stock.