Southern Foods just paid an annual dividend of $1.10 a share. Management estimates the dividend will increase by 10 percent a year for the next four years. After that, the annual dividend growth rate is estimated at 3.2 percent. The required rate of return is 12 percent. What is the value of this stock today?

$16.21

Explanation:

Worth of the stock is the present value of all the cash flows associated with the stock. Dividend is the only cash flow that a stock holder receives against its investment in the stocks. We need to calculate the present values of all the dividend payments.

Dividend Payment               $1.10    

Growth rate first 3 years10%  

Growth rate first 4 years3.2%  

Required rate of return          12%  

                                                 Dividend   Discount Factor    PV Factor

First year Dividend                     $1.21      0.892857143         $1.08  

Second year Dividend               $1.33     0.797193878          $1.06  

Third year Dividend                   $1.46     0.711780248          $1.04  

Fourth year Dividend                 $1.61      0.635518078        $1.02  

Stock value after fourth year = $18.89    0.635518078       $12.00

Stock Value                                                                            $16.21

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