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Date Posted: 09:43:13 08/07/02 Wed
Author: Dr. D.
Subject: Re: Dr.D, can you work another problem???
In reply to: N.Laster 's message, "Dr.D, can you work another problem???" on 14:51:51 08/06/02 Tue

The 1.00 is D(0), so we use it only to calculate subsequent dividends:

D(1) = 1(1.15) = $1.15
D(2) = 1.15 (1.15) = 1.3225
Since everything after D(2) grows at 5%, we can use it to get a terminal price: P(1) = 1.3225/(0.10-0.05)=26.45

So, if we bought this stock, a year from today we would receive a dividend of $1.15 and could sell our stock for $26.45==> in other words, we would have a total cash flow of $27.60 in a year's time.

Theefore, the price today would be 27.60/1.1 = $25.09

(in your calculation, you forgot to include the value of the year 1 dividend - there's your error)

>This question relates to non-constant dividend growth.
> I keep coming up with the same wrong answer and need
>some help.
>
>The question:
>McIver's Meals, just paid a $1.00 annual div.
>Investors believe that the firm will grow at 15% ann.
>for the next two years and 5% ann. forever thereafter.
> Assuming a discount rate of 10%, what is the current
>price of the stock?
>
>The answer I came up with was $24.05. The sample exam
>said that the right answer is $25.09. Can you clarify?
>
>Thank You,
>Nicolle
>P.S. Thanks for answering my other question.

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