Integrated Potato Chips just paid a $2.7 per share dividend. You expect the dividend to grow steadily at a rate of 6% per year. Required:
a. What is the expected dividend in each of the next 3 years?
b. If the discount rate for the stock is 12%, at what price will the stock sell today?
c. What is the expected stock price 3 years from now?

a.

D1 =  $2.862 rounded off to $2.86

D2 = $3.03372 rounded off to $3.03

D3 = $3.2157432 rounded off to $3.22

b.

Price today is $47.7

c.

3 years from now the price will be $56.81

Explanation:

a.

The dividend growth is expected to be constant forever. Thus, the dividend for such a stock will be calculated as follows,

Dn = D0 * (1+g)^n

Where,

D1 = 2.7 * (1+0.06)^1  = $2.862 rounded off to $2.86

D2 = 2.7 * (1+0.06)^2  = $3.03372 rounded off to $3.03

D3 = 2.7 * (1+0.06)^3  = $3.2157432 rounded off to $3.22

b.

The constant growth model of DDM will be used to calculate the price of the stock today. The formula for the stock price today under this model is,

P0 = D1 / (r - g)

Where,

P0 = 2.862 / (0.12 - 0.06)

P0 = $47.7

c.

To calculate the price of the stock 3 years from now, we will use the constant growth model. However, instead of using D1, we will use D4 to calculate the P3 or price 3 years from now.

P3 = 2.7 * (1+0.06)^4  /  (0.12 - 0.06)

P3 = $56.81

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