Nonconstant growth dividend model
The Fleming Corporation anticipates a nonconstant growth pattern for dividends. Dividends at the end of year 1 are $2 per share and are expected to grow by 16 percent per year until the end of year 5 (that’s four years of growth). After year 5, dividends are expected to grow at 6 percent as far as the company can see into the future. All dividends are to be discounted back to the present at a 10 percent rate (Ke = 10 percent).
a. Project dividends for years 1 through 5 (the first year is already given as $2). Round all values that you compute to two places to the right of the decimal point throughout this problem.
b. Find the present value of the dividends in part a.
c. Project the dividend for the sixth year (D6).
d. Use Formula 7–5 on page 168 to find the present value of all future dividends, beginning with the sixth year’s dividend. The present value you find will be at the end of the fifth year. Use Formula 7–5 as follows: P5 = D6/(Ke – g).
e. Discount back the value found in part d for five years at 10 percent.
f. Add together the values from parts b and e to determine the present value of the stock.
g. Explain how the two elements in part f go together to provide the present value of the stock.