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Date Posted: 15:52:44 12/07/01 Fri
Author: Inna K.
Subject: "decayed" dividends problem

Please help me with this problem.
"New competition in Karamazov Brothers’ market is going to have an impact on the growth in the firm’s
dividends. A current dividend of $0.92 was paid yesterday by Karamazov Brothers, and this dividend
is expected to increase by 20% in the first year. After that point, the growth in dividends is expected to
“decay” to the firm’s long-run constant growth of 5%. Such a “decay” process is one in which dividend
growth declines by 5 percentage points per year up to the point where the expected constant rate of
dividend growth is reached. So, year 2 dividend will be 15 percent higher than year 1, year 3 dividends
will be 10 percent higher and after year 3, dividends will grow by 5 percent forever. Assume investors
in Karamazov Brothers require a rate of return of 14%. Calculate the current price of Karamazov
Brothers stock."
The dividends that I came up with are C1=1.104, C2=1.058, C3=12.818(1.012+11.806), so the price=10.434. The correct price is given as $13.89. Where did I make a mistake?

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