Challenge Problem Tough times have hit the retail store chain of Brador Inc.

QUESTION

Challenge Problem Tough times have hit the retail store chain of Brador, Inc. Analysts expect its dividend of $1.00 a share to fall by 50 percent next year and another 50 percent the following year before it returns to its normal growth pattern of 3 percent a year. If investors expect a return of 18 percent on their investment in Brador stock, what should its current stock price be?
Concept: Dividend Discount Model is used to evaluate the price of share or value of stock. It uses discounted dividends to find the present value of stock. Value of stock can be calculated as: Value of Stock = Dividend 1/(1+Discount Rate) +Dividend 2/(1+Discount Rate)^2 + Dividend 2*(1+g)/(k g) Where k -> Required Rate of Return g -> Growth Rate Solution: For Brador, Inc.: Required rate of return = 18% Annual

nd amount for year 1 = $1*(1-50%) = $0.50 Annual dividend amount for year 2 = $0.50*50% = $0.25 After Year 2, Growth Rate is 3% per year. So, Value of Stock = $0.50/(1+18%) + $0.25/(1+18%)^2 + $0.25*(1+3%)/(18%-3%) = $2.32 per share Therefore, Brador, Inc. share value is $2.32 per share.

ANSWER:

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