CFA CFA Level 1 Question help: Valuing share price based on future dividend payments

# Question help: Valuing share price based on future dividend payments

Topic Resolution: Resolved
• Author
Posts
• pd25
Participant
• CFA Level 1
6

Bill Bailey and Sons pays no dividend at the present time. The company plans to start paying an annual dividend in the amount of \$.30 a share for two years commencing two years from today. After that time, the company plans on paying a constant \$1 a share dividend indefinitely. How much are you willing to pay to buy a share of this stock if your required return is 14 percent?

A: \$4.82

B: \$5.25

C: \$5.39

D: \$5.46

E: \$5.58

The right answer is B. I have understood the question but not able to get the right answer.

• shanky
Participant
• CFA Level 2
4

Isn’t the calculation in the present value of \$1 annuity incorrectly written, I got 4.23 everytime i tried?

• 1

Got a bit carried away compressing my steps and had a typo – it should be 1.143, not 1.144.

After the second payment, 3 years from now, the ‘present’ value of the \$1 perpetuity payments is 1/0.14. So calculating the present value to year 0 would be:

( 1 / 0.14 ) / 1.143

= 4.82

Sorry! ðŸ˜œ

• 3

To calculate this, sum up the present value (PV) of three components:

• \$0.30 payment 2 years from now
• \$0.30 payment 3 years from now
• \$1 annual payment to perpetuity 4 years from now

Present value of a payment to perpetuity is

PV = C / R

Where:

PV = Present value
C = Amount of continuous cash payment (\$1 in your example)
r = Interest rate or yield (14% in your example)

Calculations:

• \$0.30 payment 2 years from now = \$0.30 / 1.142 = \$0.23
• \$0.30 payment 3 years from now = \$0.30 / 1.143 = \$0.20
• \$1 annual payment to perpetuity 4 years from now = ( \$1 / 0.14 ) / 1.144 = \$4.82

Adding them all up get you the total PV

= \$0.23 + \$0.20 + \$4.82

= \$5.25

• pd25
Participant
• CFA Level 1
0

Thank you so much! I got it partially correct and now I see where I made the mistake. ðŸ™‚

• 0

No problem. If you have any further questions just create a new topic!