Name Mahrish Akhtar ID: 022-20-121366

POF Assignment 2 – (Stock Valuation)

1. Stock Values. Integrated Potato Chips paid a $2 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?

Answer:
Dividend in year 1 = 2 (1+0.04) = 2×1.04 = $2.08
Dividend in year 2 = 2.08 (1+0.04) = 2.08×1.04 = $2.1632
Dividend in year 3 = 2.163 (1+0.04) = 2.163×1.04 = $2.2497

b. If the discount rate for the stock is 12 percent, at what price will the stock sell?
Answer:
Dividend∈Yr 1 2.08 2.33
Price of the stock = = = =$ 26
Discount rate−growth rate ( 0.12−0.04 ) 0.08

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

Answer:
Dividend ∈Yr 4 2(1.04) ⁴ 2.08
Expected price in year 3 = = = = $ 2 9.24
Discount rate−growth rate ( 0.12−0.04 ) 0.08

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).
Answer:
Calculations:
2.08
=¿ 1.85714285714
( 1+ 0.12 )1

2.163
=1.72448979592
( 1+ 0.12 )2
2.2497
=1. 60129202351
( 1+ 0.12 )3

0---------------------------1--------------------------2---------------------------3-----------
2.08 2.163 2.2497

(1.85714285714)

(1.72448979592)

(1.60129202351)
Name Mahrish Akhtar ID: 022-20-121366
4.3762755102 Total
20.81705539
$26

Therefore the present value is as same as we calculated in (b).

2. The DAP Company has decided to make a major investment. The investment will
require a substantial early cash out-flow, and inflows will be relatively late. As a result,
it is expected that the impact on the firm's earnings for the first 2 years will be a negative
growth of 5% annually. Further, it is anticipated that the firm will then experience 2
years of zero growth after which it will begin a positive annual sustainable growth of 6%.
If the firm's cost of capital is 10% and its current dividend (D0) is $2 per share, what
should be the current price per share?

Answer:

First we have to calculate the dividends of the years then their present values:

first 2 years with negative growth of 5% annually

Dividend 1

D1 = 2(1- 0.05) = 1.90

Present value of d1

1.90
(PV)d1 = = 1.72
( 1+ 0.1 )

D2 = 1.95 × 0.95 = 1.85

1.85
(PV)d2 = = 1.52
( 1+ 0.1 ) ²

Second 2 years with zero growth

D3 = 1.85 (same as d2 due to zero growth)

1.85
(PV)d3 = = 1.38
( 1+ 0.1 ) ³

D4 = 1.85 (same as d3 due to zero growth)

1.85
(PV)d4 = = 1.26
( 1+ 0.1 ) ⁴

Third 2 years with positive annual sustainable growth of 6%

Name Mahrish Akhtar ID: 022-20-121366
D5 = 1.85(1+0.06) = 1.961

1.961
(PV)d5 = = 1.21
( 1+ 0.1 )5

D6 = 1.961 × 1.60 = 2.07

2.07
(PV)d6 = = 1.17
( 1+ 0.1 )6

Now for the current price per share,

Current Price = 1.72 + 1.52 + 1.38 + 1.26 + 1.12 + 1.17

Current Price = $8.29