Homework 3

In practice, the use of the dividend discount model is refined from the method we presented in the textbook. Many analysts will estimate the dividend for the next 5 years and then estimate a perpetual growth rate at some point in the future, typically 10 years. Rather than have the dividend growth fall dramatically from the fast growth period to the perpetual growth period, linear interpolation is applied.

That is, the dividend growth is projected to fall by an equal amount each year.

For example, if the high growth period is 15 percent for the next 5 years and the dividends are expected to fall to a 5 percent perpetual growth rate 5 years later, the dividend growth rate would decline by 2 percent each year.

Homework 3 I Below, you will find information for Microsoft found in the 2018. 2018 dividend = $1.56 5-year dividend growth rate = 12.0% and we will assume the following: Perpetual growth rate = 5.0% Required return = 11.0% Assume that the perpetual growth rate begins 10 years from now(at the beginning of 11th year) and use linear interpolation between the high growth rate and perpetual growth rate.

(a) Construct a table that shows the dividend growth rate and dividend each year.

(b) What is the stock price at Year 11?

(c) What is the stock price today?