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Phoenix Industries has pulled off a miraculous recovery
Phoenix Industries has pulled off a miraculous recovery. Four years ago, it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the first dividend since the crisis. Analysts expect dividends to increase by $2 a year for another 3 years. After the fourth year, dividend growth is expected to settle down to a more moderate long-term growth rate of 5 percent. If the firm’s investors expect to earn a return of 15 percent on this stock, what must be its price?
Expert Solution
Year 1 dividend = 1
Year 2 dividend = 1 + 2 = 3
Year 3 dividend = 3 + 2 = 5
Year 4 dividend = 5 + 2 = 7
Year 5 dividend = 7 (1 + 5%) = 7.35
Value in year 4 = Year 5 dividend / required rate - growth rate
Value in year 4 = 7.35 / 0.15 - 0.05
Value in year 4 = 7.35 / 0.1
Value in year 4 = 73.5
Price = Present value of future cash flows
Present value = Future value / (1 + rate)^periods
Price = 1 / (1 + 0.15)^1 + 3 / (1 + 0.15)^2 + 5 / (1 + 0.15)^3 + 7 / (1 + 0.15)^4 + 73.5 / (1 + 0.15)^4
Price = $52.45
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