The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 21 percent a year for the next 4 years and then decreasing the growth rate to 5 percent per year. The company just paid its annual dividend in the amount of $2.80 per share. What is the current value of one share of this stock if the required rate of return is 8.30 percent?a. $153.71b. $138.82c. $193.77d. $156.51e. $190.97

a. $153.71

Explanation:

First, calculate the yearly dividend

First-year dividend = $2.80 x ( 1 + 21% ) = $3.388

Second-year dividend = $3.388 x ( 1 + 21% ) = $4.099

Third-year dividend = $4.099 x ( 1 + 21% ) = $4.960

Fourth-year dividend = $4.960 x ( 1 + 21% ) = $6.002

Now calculate hte terminal value of the dividend payment after 4 years

Terminal value = Fourth year dividend x ( 1 + Growth rate after year 4 ) / ( Required rate of return - Growth rate after year 4 ) = $6.002 x ( 1 + 5% ) / ( 8.30% - 5% ) = $190.97

Now use the following fromula to calcula the value of the bond

Value of the bond = ( First-year dividend / ( 1 + Required rate of return )^1 ) + ( Second-year dividend / ( 1 + Required rate of return )^2 ) + ( Third-year dividend / ( 1 + Required rate of return )^3 ) + ( Fourth-year dividend / ( 1 + Required rate of return )^4 ) + ( Terminal Value / ( 1 + Required rate of return )^4 )

Value of the bond = ( $3.388 / ( 1 + 8.3% )^1 ) + ( $4.099 / ( 1 + 8.3% )^2 ) + ( $4.960 / ( 1 + 8.3% )^3 ) + ( $6.002 / ( 1 + 8.3% )^4 ) + ( $190.97 / ( 1 + 8.3% )^4 )

Value of the bond = $3.128 + $3.495 + $3.905 + $4.363 + $138.820

Value of the bond = $153.711

Value of the bond = $153.71

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