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General Importers announced that it will pay a dividend of $3.30 per share one year from today. After that, the company expects a slowdown in its business and will not pay a dividend for the next 5 years. Then, 7 years from today, the company will begin paying an annual dividend of $1.40 forever. The required return is 10.7 percent. What is the price of the stock today?

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jepessoa

Answer:

$9.40

Explanation:

First we have to calculate the future value of the stock when it starts to pay the $1.40 using the perpetuity formula:

stock price in 7 years = $1.40 / 10.7% = $13.08

Now we have to find the present value of both next year's dividend and the perpetuity:

stock price = ($3.30 / 1.107) + ($13.08 / 1.107⁷) = $2.98 + $6.42 = $9.40