Question

Hi-Tek is a young start-up company that is currently retaining all of its earnings. The company plans to pay a $2 per share dividend in Year 7 and increase that dividend by 2.2 percent per year thereafter. What is the current share price if the required return is 16 percent?

Answer 1

Answer:

$5.95

Explanation:

Given that,

Dividend paid in Year 7 = $2 per share

Growth rate of dividend = 2.2%

Required return = 16 percent

Share price is the present value of all future dividends.

Present Value of future dividends at year 6:

= $\frac{Dividend\ in\ year\ 7}{Required\ return - Growth\ rate}$

= $\frac{2}{0.160 - 0.022}$

= $\frac{2}{0.138}$

= $14.49

Present value of dividends (Now):

= Present Value of future dividends at year 6 × (1 + Required return)^{-6}

= $14.49 × (1 + 0.16)^{-6}

= $5.95

Therefore, the current share price is $5.95 if the required return is 16 percent.